Ebook CEO Pay Levels and Firm Diversification: The Premium for Operating in Multiple Countries
Prior work finds that a significant determinant of the level of CEO pay is whether the firm is diversified across multiple business segments. For example, Rose and Shepard (1997) document evidence that CEOs who operate in firms with two lines of business average a premium of 12% of salary and bonus and 14% of total compensation over CEOs who operate in firms with a single line of business. An unexplored issue from this and related work is whether the complexity of operating in multiple businesses drives this premium, or, if other economic characteristics drive the CEO pay premium observed when firms diversify by business segments.
For example, US based multi-national enterprises (hereafter, MNEs) face cross border constraints such as language barriers, legislative differences, and cultural differences, relative to enterprises that either operate solely in the United States or are MNEs that do not disclose material international operations. We conjecture that cross-country constraints likely drive the CEO pay premium either in addition to, or instead of, the CEO pay premium documented for enterprises operating in more than one business segment.
In this study we investigate two main research questions. First, is the CEO pay premium for business segment diversification the same for domestic corporations as it is for MNEs with, or without, material subsidiaries in multiple foreign countries? Second, what are the economic determinants of a MNE’s CEO pay premium for multinational diversification? In addressing the first of these questions, we study whether pay effects from multinational diversification are incremental to pay effects from business segment diversification. If the pay premium for business segment diversification is due to the complexity of business operations independent of the location of operations, then considering multinational diversification is unlikely to explain the pay premium. If, however, establishing subsidiary operations in multiple countries drives the CEO task complexity associated with diversification, then it is likely that the pay premium may be explained (or is potentially increased) by expanding the firm across international borders. We examine whether a CEO receives a pay premium that is increasing in the number of countries in which the MNE has material subsidiaries.
In addressing our second research question, we investigate whether the CEOs of MNEs are rewarded or penalized for establishing material subsidiaries in countries with tax havens. Prior work has found that MNEs disclosing material subsidiaries in at least one tax haven country have an effective tax rate that is 1.5 percentage points lower than MNEs without material subsidiaries in at least one tax haven country (Dyreng and Lindsey 2009). The CEO could be rewarded with increased pay if locating in a tax haven is viewed as effective tax planning. On the other hand, to the extent that international expansion is used primarily to divert a firm’s domestic resources away to tax havens, a CEO may be penalized relative to other MNE CEOs. Building on this analysis, we also study the effects on the level of CEO pay of differences in a country’s (1) official language (2) corruption (3) legal origin, and (4) geographic region, controlling for standard economic determinants of the level of CEO pay.
We first replicate Rose and Shepard (1997) to demonstrate in a more recent time period a CEO pay premium associated with operating in more than one business segment. Next, using regulatory disclosures about the countries in which subsidiaries operate (provided in Exhibit 21 of the annual 10K reports of US firms) we identify a measure of the number of countries in which a firm operates. We then include this measure in a multivariate regression of the level of CEO pay on economic determinants identified in prior work, including the diversification measure identified by Rose & Shepard (1997). Next, we analyze whether and to what extent the number of countries accounts for the diversification premium identified in prior work. To the extent that the pay premium can be replicated, we explore to what extent it is attributable to effective tax planning, as captured by the expansion of the firm into foreign tax havens. Finally, we regress CEO pay on standard economic determinants and separate classifications of material MNE foreign subsidiaries by legal origin, the level of corruption, language differences, and geographic region.
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