An application of Data Envelopment Analysis to benchmark CEO remuneration

Abstract

The purpose of this study is to determine whether the Data Envelopment Analysis (DEA) can be applied to Chief Executive Officer (CEO) remuneration of companies listed on the Johannesburg Stock Exchange (JSE) by defining inputs in terms of remuneration factors and outputs in terms of business factors in order to establish a benchmark for CEO remuneration. An exploratory study is conducted, using cross-sectional data from a secondary source. The sample consists of 221 companies listed on the JSE that disclosed their financial and non-financial information during 2010. The DEA was performed to estimate the relative technical efficiency of CEOs to convert their remuneration into company performance indicators. Base Pay, Perquisites and Pension, Annual Bonus Plans and Long-term Incentives were used as the inputs to the DEA model and company performance and size, measured by Return on Equity (ROE) and Total Assets respectively, were used as the outputs to the model. The empirical results prove that the DEA can be successfully applied as a benchmarking model for CEO remuneration that incorporates multiple inputs and outputs and establishes benchmarks and potential improvements for overpaid, inefficient CEOs. The CEOs from 80 of the 221 companies included in the sample emerged as the benchmark CEOs and formed the efficiency frontier against which inefficient CEOs were compared in order to determine the potential improvements for these CEOs. From a research perspective, this study contributes to the advancement of CEO remuneration research by introducing an alternative model by which CEO remuneration can be analysed. Future studies can analyse CEO remuneration by using other variables or time series data in the DEA model or combine the DEA with other methods like the regression analysis to perform more comprehensive investigations. From a practical perspective, the DEA can be used to establish a benchmark for CEO remuneration. Remuneration committees can use the results of the DEA as a guide to determine acceptable remuneration levels and decrease the pay gap between CEOs and the average worker. The originality of this study lies in the fact that it is the first South African study that used the DEA instead of the regression analysis to analyse CEO remuneration of companies listed on the JSE. This study also disaggregated Total CEO Remuneration into Base Pay, Perquisites and Pension, Annual Bonus Plans and Long-term Incentives to provide more accurate benchmark information. In addition, this is the first study that established benchmark CEO remuneration levels and suggested improvements to the remuneration package structure of overpaid, under-performing CEOs of companies listed on the JSE.