CEO Compensation in a Regulatory Environment: An Analysis of the Electric Utility Industry

Abstract

Prior studies argue that a firm's investment opportunity set affects the level of information asymmetry and thereby the structure of CEO compensation. We test whether the political constraints imposed in a regulatory environment incrementally affect both the level and the structure of CEO compensation, while controlling for the effects of investment opportunity set and other firm characteristics. We hypothesize that increased political constraints reduce the need and the opportunity to pay management bonuses, stock options, and other incentive-based compensation, in addition to a base salary. We test our hypothesis using CEO compensation data from electric utility companies during 1990–1995. We develop refined measures for different levels of regulation and monitoring within the electric utility industry. Our results provide evidence that increased political constraints affect both the level and structure of CEO compensation, after controlling for investment opportunity set and other firm characteristics, such as firm size, systematic risk, and performance.

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