Board Effectiveness and CEO Pay: Board Information Processing Capacity, Monitoring Complexity, and CEO Pay-for-Performance Sensitivity

Abstract

We have developed an information processing theory of board effectiveness to examine board-chief executive officers (CEOs) pay relations. We theorize that CEO pay reflects the information processing context of boards. Boards have limited information processing capacity and therefore prefer to use outcome-based CEO pay when they have difficulty in processing information for monitoring their CEOs. Using a longitudinal sample of Standard and Poor's (S&P's) large-, medium-, and small-cap manufacturing firms in the United States from 1998 through 2005, we found support for our theory. Large boards and boards in less complex monitoring contexts tend to link CEO pay less tightly to firm performance by providing less stock-based incentives, and the tendency of large boards to decrease outcome-based CEO pay is even greater when boards are not busy or when boards are in less complex monitoring contexts. © 2015 Wiley Periodicals, Inc.