Political ideology of corporate boards influences CEO compensation

Firms governed by politically conservative boards of directors pay their CEOs more money than do firms with more liberal-leaning boards.

That’s the conclusion of a new study on the impact of political ideology in the boardroom by Abhinav Gupta, an assistant professor of management at the University of Washington Foster School of Business.

Gupta also finds an ideological disparity in the degree to which directors link pay to merit. Relative to their liberal counterparts, conservative-leaning boards tie CEO pay more closely to firm performance. They offer bigger financial rewards after periods of strong earnings or stock returns, and impose harsher penalties after periods of weak performance.

But meritocracy has its limits—in this case a lower limit. The study indicates that even the poorest performing chief executive will fare no worse with a conservative board setting his compensation than he would with a liberal board.

“Our findings suggest that conservatives are more likely to believe CEOs have a lot of influence on firm performance,” Gupta says, “while liberals are more likely to attribute firm performance to social structures, market conditions and broader environmental factors.”

Fair pay?

How much is a CEO worth to an organization?

It’s a hotly debated question in American fiscal discourse, especially as the pay gap between chief executives and frontline workers grows ever vaster.

Of course, this debate is largely academic for all but the few whose votes really matter: the corporate directors who set compensation packages for their firms’ senior leadership.

Boards have a fiduciary responsibility to ensure that CEOs are paid the appropriate amount to serve the best interest of shareholders. But what’s “appropriate” is highly subjective.

“Pay is the most observable manifestation of directors’ biases about how much CEOs matter to the success of their organizations,” Gupta says.

He wondered if those biases might be directed by political beliefs.

The elephant (or donkey) in the boardroom

To find out, Gupta collaborated with Adam Wowak of the University of Notre Dame. The researchers tracked the pay and performance of more than 4,000 CEOs of S&P 1500 firms from 1998 to 2013. They also tallied donations by those firms’ corporate directors to political parties and candidates over the same period, establishing an ideology score for each board along the left-right spectrum.

To create an apples-to-apples comparison of CEO pay, they controlled for firm size, age, industry, sales growth and other factors in compensation decisions. This allowed them to isolate the relative effect of political ideology on CEO pay across a wide range of public companies, from Amazon to Zoetis.

After leveling the landscape, Gupta and Wowak found that conservative boards, on average, paid their CEOs four percent more money than liberal boards paid theirs. This translates to approximately $140,000 in additional compensation for the typical chief executive.

When they factored recent firm performance into the equation, they found that good times brought an even bigger premium in compensation. After a period of strong earnings or increased market capitalization, conservative boards paid their CEOs 18 percent more than CEOs who report to liberal boards.

The difference in CEO pay across liberal and conservative boards was much smaller, however, following poor performance.

Know your biases

What’s going on here?

Gupta credits the observed conservative pay premium to a philosophical difference in the way that liberals and conservatives view the impact of individual leaders.

“Directors’ political ideologies shape their perceptions of how much—or how little—CEOs matter to a firm’s profitability and survival,” he says. “We find evidence that conservative boards are more inclined to believe that the fortunes of an organization hinge on the actions of its CEO. And this higher assessment of CEO impact translates into higher CEO pay.”

He adds that conservative directors would argue this is good governance. After all, it is their responsibility to recruit and retain uniquely talented CEOs, a task that takes on heightened importance when CEOs matter—or are perceived to matter—a great deal to the organizations they lead.

Gupta suggests that corporate directors should be aware that their political beliefs are shaping their views and influencing their approach to governance, which is supposed to be rational and objective.

“Political biases creep into these really important decisions. To understand that this is happening is informative,” he says. “The question is: if you knew about your biases, would it make you more reflective? Would it alter your behavior?”

“The Elephant (or Donkey) in the Boardroom: How Board Political Ideology Affects CEO Pay” is published in the March 2017 issue of the journal Administrative Science Quarterly.