Existing research shows that deal-making CEOs are rewarded for mergers even if the transactions are unsuccessful. To determine whether the CEOs are being rewarded for the deals themselves or for the byproducts of such deals, such as an increase in firm size and complexity, the authors analyze generally overlooked deals that do not increase firm size or complexity: joint ventures, strategic alliances, seasoned equity offerings (SEOs), and spinoffs.

The authors examine whether boards of directors consider deal activity when structuring CEO pay and whether pay increases for deal-making CEOs are linked to firm performance. They also examine the motivation for such deals to assess whether specific deal features are more likely to elicit a pay increase.

First, the authors review compensation committee reports for firms in their sample to determine whether boards of directors consider deal activity when structuring their CEOs’ pay. Their findings suggest that deal making is an important component of boards’ compensation decisions. Their analysis shows that a CEO who initiates a joint venture, strategic alliance, SEO, or spinoff receives, on average, an additional $400,000 in total compensation.

Second, the authors’ analysis shows that compensation for deal-making CEOs is sensitive to good performance but insensitive to bad performance, suggesting that deal-making activities insulate CEOs from poor performance. It also shows that deal making can insulate CEOs from the risk of being fired for poor performance.

In light of the findings, the authors test the motivation for each deal: Is it more consistent with a core (organic) growth motivation (as proxied by the market reaction to announcements) or is it more consistent with empire building (insulation motivation)? Their test results show that some CEOs receive pay raises irrespective of whether the transactions are expected to improve firm value. These findings suggest that using deal making as a contractible measure to set executive pay could lead to agency problems.

The authors then examine the quality of board governance as a potential explanation for why a CEO could persist in empire-building deals that are detrimental to shareholders. They find that firms with potentially weaker board monitoring are more likely to execute non-value-increasing or insulating deals and are more likely to issue higher pay raises and give more perks to their deal-making CEOs.

The ongoing debate on executive pay triggered by the recent financial crisis includes several stakeholders—academics, regulators, politicians, boards of directors, and remuneration committees—and they will all find this article useful. The authors’ research is especially useful for boards of directors that are considering and structuring executive pay contracts.

Additionally, the methods and approaches used in the authors’ analyses, such as estimating CEO and board effectiveness, are creative and can be used by investment analysts who want to factor CEO effectiveness and the effectiveness of board monitoring into their analyses.

The authors’ sample of deal-making firms consists of firms executing one or more of these deals—joint venture, strategic alliance, SEO, or spinoff—between 1996 and 2006 for which data are available from the Thomson Financial database. Additional data are gathered from the Securities Data Company databases.

Each sample observation has data on CEO compensation (from the ExecuComp database) for the year preceding, the year of, and the year after the deal is undertaken as well as governance data from the RiskMetrics database, accounting and stock market data from the Compustat database, and the CRSP daily stock file. The full sample of deal-making firms (excluding observations without data) consists of 4,990 observations.

Non-deal-making companies that have complete compensation, governance, stock market, and accounting data from the sources the authors use are included in the analyses. In total, both samples constitute 11,815 firm-year observations from 1996 to 2006.

The average firm in the sample has about $13.8 billion in assets and 10 board directors, 66% of whom are independent. CEOs in the sample receive an average total annual compensation of more than $5.4 million, and the median is $2.8 million.

Market reaction is used as a proxy for the deal motivation: negative reaction for empire building or positive reaction for core organic growth. The authors estimate market reactions to deals using a standard event study methodology to calculate market-adjusted abnormal returns.

To examine whether boards considered deal-making activities in their CEO pay decisions, the authors study the compensation committee disclosures filed by the companies with the SEC. Because of the large size of the dataset, they use sampling theory to devise a sample of firms (400 each for deal-making and non-deal-making samples) that yields reliable results.

Finally, the authors examine the impact of deal making on CEO pay using regressions across the entire sample (11,815 firm-year observations). The key independent variable is whether the firm executes one of the relevant deals. A similar approach is used to examine effectiveness of board governance, with the independent variable being whether the firm executes one of the relevant deals.

By focusing on often-overlooked deals that do not necessarily increase the size and complexity of firms, the authors have effectively explored the question of whether deal-making CEOs are being rewarded for deal volume or the core motivation of a deal. The design of the data analysis driving their suggestions and conclusions is creative and suitable to the stated objective of the article. Additionally, the research gives an objective, data-driven analysis of the context (poor board governance) that can permit persistent rewards for deals that do not add value for shareholders. This approach is also creative in itself and could be a useful addition to an investment analyst’s toolkit for evaluating firm performance.