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Posted 4.27.10

Various papers have recently documented that distance matters in economic transactions. There are several reasons to believe it could matter in executive compensation as well, in the sense that CEO compensation (salary and cash compensation) may depend on how much geographically-close CEOs earn.

These include:

  1. The force of local labor market competition for CEOs
  2. The effect of "leading firms" in the vicinity as suggested by the literature on social interaction
  3. Envy among geographically-close CEOs endowed with relative consumption preferences

In 2008, Christa Bouwman, PhD, assistant professor of Banking and Finance, first examined whether geography does, in fact, matter for CEO compensation, and then explored the possible reasons for this relationship. What Dr. Bouwman found was strong evidence that CEO compensation is positively and significantly related to the level of compensation of CEOs of firms headquartered within a one-hundred kilometer or 250-kilometer radius. For example, her research results suggest that if CEOs within a one hundred- kilometer radius enjoyed a one dollar salary increase in the previous year, the CEO will experience a twenty-nine cent increase in salary this year ceteris paribus. According to the 2006 CNN.com article "How to End CEO Pay Envy," "Every company that wants to stay competitive needs to be able to advertise that it pays its execs as well as the next company."

These results were obtained while controlling for previously-documented factors that affect CEO compensation, including CEO age, CEO tenure, firm size, growth options, and firm performance. All regressions also include the average CEO compensation at similar-sized industry peers, and proxies for local market conditions to help ensure that the results are not driven by differences in per-capita income or the cost of living. Year and industry fixed effects are included in all regressions; the results are similar when state fixed effects are added or when firm fixed effects are used instead of industry fixed effects. The results are robust to using a variety of alternative specifications, including the addition of corporate governance proxies, excluding New York and California from the sample, restricting the sample to electric utilities, and the use of log-transformed variables.

An examination of what drives this relationship between geography and executive compensation reveals that the results are most consistent with envy. Robustness checks were conducted to deal with issues related to potentially omitted variables and endogeneity, and the results survived these checks.

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