Executive Compensation and Ethnic Minority Status

• Date: 01 July 2017
• Author: Paul M. Guest
• DOI: http://doi.org/10.1111/irel.12181
• Published date: 01 July 2017

Executive Compensation and Ethnic Minority

Status*

PAUL M. GUEST

We examine the compensation of ethnic minority executives in listed U.S. firms.

The total pay of African American executives is 9 percent lower than that earned

by Caucasians. This is due to lower base salary, lower bonus, and lower restricted

stock grants. The lower bonus is due to a lower sensitivity to above-average firm

performance. African Americans also earn significantly less on the exercise of

stock options, increasing the pay gap to 17 percent for total ex-post pay. In con-

trast to African Americans, the compensation of Hispanic and Asian executives is

comparable to Caucasians.

Introduction

Over the last 30 years, ethnic minorities have been increasingly represented

within the executive ranks at U.S. firms. In 1979, just 0.05 percent of execu-

tives at Fortune 1000 firms were of an ethnic minority background (Jones

1986). By 2010, we estimate that of 2682 executives at S&P 1500 firms, 6.8

percent are ethnic minorities. These executives represent an important and

interesting group, race and ethnicity being important personal attributes that

may impact executives’treatment and behavior. In this paper we empirically

examine the compensation outcomes for these executives.

Such evidence is important because it may shed light on whether minority

executives suffer discrimination, which is an issue of significant social, eco-

nomic and political importance (Federal Glass Ceiling Commission 1995).

Minority executives could be disadvantaged by prejudice, statistical

*The author’saffiliation is University of Surrey, Guildford, United Kingdom Email: p.guest@surrey.ac.uk.

JEL: J15, J31, J71.

INDUSTRIAL RELATIONS, Vol. 56, No. 3 (July 2017). ©2017 Regents of the University of California

Published by Wiley Periodicals, Inc., 350 Main Street, Malden, MA 02148, USA, and 9600 Garsington

Road, Oxford, OX4 2DQ, UK.

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discrimination, or racebased stereotyping, leading to lower compensation.

There is anecdotal evidence of perceived racial discrimination in executive

pay, such as the following quote from an African American executive:

I’m experiencing that right now. They bring in a new CFO ... even

though I’ve been running things. They pay him twice as much as me

and I’ve been there 10 years. I see the salary differences between

Blacks and Whites. (Federal Glass Ceiling Commission 1995: 70).

The Federal Glass Ceiling Commission (1995) concluded that pay discrimi-

nation is widespread, noting that where minorities, “are in top positions, they

are not being rewarded equally”(1995: 80).

We contribute to the labor economics literature on racial pay differences,

executive pay studies on gender, and a small number of studies that examine

ethnic minority executives (Guest 2016; Hill, Upadhyay, and Beekun 2015;

Park and Westphal 2013; Zweigenhaft and Domhoff 2011). Discrimination

may also take place through mobility, and Guest (2016) shows that while eth-

nic minority executives as a whole face similar mobility patterns to Cau-

casians, African Americans face a lower likelihood of promotion and higher

likelihood of demotion and exit. The only executive pay study on ethnic

minorities is Hill, Upadhyay, and Beekun (2015), who find ethnic minority

chief executive officers (CEOs) earn higher pay than Caucasians.

1

We examine

a much larger sample that includes other executive officers for whom discrimi-

nation is more relevant (Newton and Simutin 2015), and consider individual

ethnic groups.

While discrimination is a key hypothesis, a limitation of our approach is that

compensation differences are not direct tests of discrimination and may be

caused by executive characteristics such as ability, effort, and risk preferences.

Such characteristics may be unobservable and may differ by ethnicity, because

ethnic minority executives are unlikely to be a random sample that differs

from Caucasians in terms of ethnicity alone. While such differences arguably

diminish as one moves up the corporate hierarchy (Bertrand and Hallock

2001), they could still be significant and account for any observed differences

in pay.

Our key findings are as follows: The total pay of African American execu-

tives is 9 percent lower than that earned by Caucasians. This is due to lower

salary, bonus, and stock grants. African Americans also earn less on option

1

At the CEO level there are anecdotal examples of ethnic minorities receiving controversially high com-

pensation such as Derek Raines (Fannie Mae) (Bebchuk and Fried 2005), along with Vikram Pandit (Citi-

group) and Fernando Aguirre (Chiquita Brands), both of whom had their pay packages voted down by

shareholders in 2011.

428 / PAUL M.GUEST

exercise, increasing the pay gap to 17 percent for total ex-post pay. The lower

bonus is due to a lower sensitivity to above-average firm performance. If the

lower compensation were the result of discrimination, it could diminish with

ethnic minority presence in pay-setter positions. However, we find no such

evidence. In contrast to African Americans, the compensation of Hispanic and

Asian executives is comparable to Caucasians.

The paper proceeds as follows: the next section discusses related literature,

followed by sections describing the data, and the findings. The final section

concludes.

Related Literature

In this section we review different explanations for ethnicity-based differ-

ences in executive compensation along with the existing empirical evidence.

Theoretical literature on executive compensation and discrimina-

tion. Boards, and in particular compensation committees, set the pay levels

and structures of executives. The CEO, however, plays a key role in the com-

pensation of other executives, assessing their performance and making a pay

recommendation to the committee (Newton and Simutin 2015). Therefore, the

key decision maker is different for the CEO (compensation committee) and

other executives (CEO in conjunction with the compensation committee). This

distinction is relevant to the subsequent discussion and empirical tests.

Principal agent theory shows how executive pay is optimally set given exec-

utive ability, effort, and risk preference (Murphy 1999). In contrast, the man-

agerial power theory posits that powerful CEOs capture outside directors on

the compensation committee and consequently earn inefficiently high pay

(Bebchuk and Fried 2003). Within either framework, discrimination may oper-

ate against ethnic minority CEOs and lower executives resulting in lower pay.

MacLeod (2003) shows, within a principal agent framework, how introducing

subjective evaluation can result in discrimination and a second-best solution.

Within a managerial power framework, ethnic minority CEOs may find it

harder to capture compensation committees if the latter are discriminatory,

resulting in less excessive (but more efficient) pay. Theories in economics and

social psychology show why the compensation committee (to the extent it is

predominantly Caucasian) may discriminate against ethnic minority CEOs, and

why a Caucasian CEO may discriminate against ethnic minority executives.

Economic theories are based on either prejudice (Becker 1971) or statistical

discrimination (Arrow 1973; Phelps 1972). Compensation committee members

may be prejudiced and have a taste-based preference to minimize interaction

Executive Compensation and Ethnic Minority Status / 429