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Do Proxy Disclosures Encourage Cheating?

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September 07, 2016 | Barbara Baksa

Do Proxy Disclosures Encourage Cheating?

The question of the role of compensation in encouraging risk-taking and cheating on the part of executives is an ongoing debate (for example, see "CEOs with Stock Options Are More Likely to Break Laws," by Dylan Minor, Harvard Business Review, May 26, 2106).  But a couple of recent studies that I heard about on a podcast make me wonder if it isn't the amount or type of compensation that is the problem but more so the disclosure of it.

The Studies

I make dinner every night and doing so invariably involves endless chopping of vegetables. This gives me a LOT of time to listen to podcasts. One podcast I listen to regularly is NPR's Hidden Brain, which discusses patterns in human behavior. A recent episode ("The Cheater's High and Other Reasons We Cheat") discussed social science research on cheating, specifically the social contexts in which people cheat.

The podcast discussed one study ("Cheating More for Less: Upward Social Comparisons Motivate the Poorly Compensated to Cheat" by Leslie John of Harvard Business School, George Loewenstein of Carnegie Mellon University, and Scott Rick of the University of Michigan) that found that people are more likely to cheat when they are aware that others are doing better than them. The subjects of the study were compensated at varying rates for performing a self-reported trivia task. The subjects were more likely to cheat when they knew that others in the experiment were earning more than them. The more easily they had access to the information about how others were compensated, the more likely they were to cheat. According to the authors of the study:

Our results suggest that low pay-rates are, in and of themselves, unlikely to promote dishonesty. Instead, it is the salience of upward social comparisons that encourages the poorly compensated to cheat.

A second study ("Winning a Competition Predicts Dishonest Behavior" by Amos Schurr of Ben-Gurion University of the Negev and Ilana Ritov of the Hebrew University of Jerusalem) found that people who won a competition were more likely to cheat on subsequent unrelated tasks. The propensity to cheat was tied directly to winning (i.e., performing better than their peers), not succeeding at personal goals or in games of chance.

Executive Compensation Disclosures and Cheating

When I listened to the podcast, I immediately thought of the executive compensation disclosures in the proxy statement. The disclosures provide an easy way for executives to compare their pay to their peers'. Not only is the information readily available on the SEC website, but it is fodder for any number of published studies on executive compensation. For proof, just look at the NASPP's Surveys & Studies Portal. I count at least four or five such studies that are published annually, one of which is published in the Wall Street Journal.  And that's just among the studies that I have permission to post on the website. I'm sure there are more that I'm not aware of. If you are among the top five highest executives, I'm pretty sure you have an idea of how your compensation compares to your peers'.

On top of that, in recent years executive pay has shifted more and more towards performance-based compensation, which enables executives to increase the amount they are paid by improving company performance. We've also seen a significant shift toward measuring performance based on relative TSR—that is, how well a company performs as compared to its peers.  Companies that rank higher against their peers "win" and those executives are paid more. Given the results of the two studies described above, this seems like a recipe for executives to cheat.

- Barbara

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