Independent directors may be far more effective at controlling executive pay than critics claim, according to new research from the University of Surrey. Researchers found that companies with more independent board members move faster to correct risky CEO compensation structures.
The study, published in European Financial Management, focused on “inside debt” which includes pensions and deferred compensation awarded to chief executives. Unlike bonuses or shares, these payments can encourage CEOs to become more cautious because their personal wealth becomes more tied to the long-term financial health of the company.
The findings challenge the long-running argument that boards simply rubber-stamp executive pay packages shaped by powerful CEOs. Instead, the research suggests independent directors actively intervene when compensation arrangements drift too far from what is considered financially healthy for a company.
The study 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 an estimated optimum level and whether board independence influenced that process.
Researchers found that firms with a higher proportion of independent directors adjusted CEO compensation more quickly towards what they calculated to be the optimal level. The effect was strongest in companies with high growth opportunities, financially unconstrained firms and businesses led by overconfident chief executives where the risks of poor incentive structures are often greater. Researchers measured how far CEO compensation had drifted from what they calculated to be the “optimal” level for each company, based on factors such as firm size, debt levels, growth opportunities, financial risk and CEO characteristics. They then tracked how quickly boards adjusted those pay structures back towards that benchmark over time.
Researchers also discovered that companies with more independent directors adjusted risky CEO compensation structures significantly faster than firms with less independent boards. The effect was strongest in high-growth firms, financially secure businesses and companies led by overconfident chief executives where poor incentives can create greater risks for shareholders.
The study also found that boards appear to make calculated trade-offs rather than blindly cutting or increasing compensation. When the risks linked to CEO inside debt were lower, independent boards moved more slowly, suggesting directors weigh the costs and benefits of changing pay structures rather than reacting automatically.
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.”
Dr Shuhui Wang, co-author of the study and Senior Lecturer in Finance at the University of Surrey, said:
“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 research argues that inside debt has received far less public attention than share-based rewards despite having major influence over corporate decision-making. Because inside debt can encourage CEOs to become overly cautious, boards may use it strategically to balance risk-taking and long-term stability.
The findings also suggest board independence mattered more than pressure from institutional investors or major shareholders when it came to adjusting executive compensation structures.
Bonnie Buchanan continued:
“This matters because executive pay shapes how companies behave. If boards get those incentives wrong, it can affect investment decisions, growth and ultimately shareholder value. Strong independent oversight appears to play an important role in keeping those incentives balanced.”
ENDS