Independent directors may play a much stronger role in controlling executive pay than critics have long assumed, according to new research from the University of Surrey. The study found that companies with a higher proportion of independent board members move more quickly to correct risky CEO compensation structures, challenging the idea that boards approve pay arrangements shaped by powerful executives. The research, published in European Financial Management, suggests independent directors actively intervene when compensation packages drift too far from levels considered financially healthy for a company.
The study focused on “inside debt”, which includes pensions and deferred compensation awarded to chief executives. Unlike bonuses or share-based rewards, inside debt ties a greater portion of a CEO’s personal wealth to the long-term financial health and stability of the company. As a result, it can encourage executives to behave more cautiously and avoid excessive corporate risk-taking. While public debates around executive pay often focus on salaries, bonuses and stock options, the researchers argue that inside debt has received far less attention despite its major influence on corporate decision-making and long-term strategy.
Researchers analysed 6,357 firm-year observations across 942 US companies between 2006 and 2019. Using executive compensation, accounting and governance data, they examined how quickly firms adjusted CEO inside debt towards what they calculated to be an “optimal” level. That benchmark was estimated using factors such as company size, debt levels, growth opportunities, financial risk and CEO characteristics. The team then tracked how rapidly boards corrected compensation structures when they deviated from those targets over time.
The findings showed that firms with more independent directors adjusted CEO compensation significantly faster than companies with less independent boards. The effect was strongest in high-growth firms, financially unconstrained businesses and companies led by overconfident chief executives, where poorly designed incentives can create greater risks for shareholders. Researchers also found that independent directors appeared to make calculated trade-offs rather than reacting automatically. When the risks associated with CEO inside debt were lower, boards moved more slowly to adjust compensation structures, suggesting directors carefully weighed the costs and benefits of intervention before making changes.
Bonnie Buchanan, co-author of the study and Associate Dean (International – FABSS) and Professor of Finance at the University of Surrey, said: “There is a common perception that boards are often powerless when it comes to executive pay, particularly when dealing with influential CEOs. What we found is much more nuanced. Independent directors appear willing to step in and adjust compensation structures when they believe shareholders could be exposed to unnecessary risk.” Co-author Shuhui Wang added: “Executive compensation has become incredibly complex over the last two decades. Our findings suggest independent directors are not simply approving pay packages without scrutiny. They are making detailed decisions about when faster intervention is needed and when a slower approach makes more sense.”
The researchers also found that board independence appeared to matter more than pressure from institutional investors or major shareholders when it came to adjusting executive compensation structures. According to the study, this has important implications for corporate governance because executive pay strongly influences how companies behave, including decisions around investment, growth and risk-taking. Buchanan said the findings highlight the importance of strong independent oversight in maintaining balanced incentives within firms. The study concludes that independent boards may serve as a critical safeguard in ensuring executive compensation supports both long-term corporate stability and shareholder interests rather than encouraging excessive risk or unchecked managerial power.
More information: Bonnie Buchanan et al, Board Independence and Adjustment Speed of CEO Inside Debt, European Financial Management. DOI: 10.1111/eufm.70066
Journal information: European Financial Management Provided by University of Surrey