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Executive compensation has attracted widespread attention in recent years and has become one of the focus topics in corporate governance (Felton, 2004). At least three reasons have contributed to this increased attention on executive compensation for academics and practitioners alike: A fascination with - and sometimes lack of understanding for -the high levels of CEO compensation, the importance of the CEO as the main strategic decision maker and the increased transparency of executive compensation data in many countries.

The general roles of the board of directors are to set the company’s strategic direction, to advise and monitor top management and to otherwise protect the interests of shareholders (e.g. Styles and Taylor, 2003; Hilb, 2005). Determining executive pay is an important task in fulfilling the board’s duties (Finkelstein and Hambrick, 1996). This chapter describes institutional details of the executive pay setting process.

The number of research papers on executive pay has increased dramatically over the last few decades. Academics of such diverse fields as accounting (e.g. Antle and Smith, 1986), economics (e.g. Jensen and Murphy, 1990a), finance (e.g. Baker et al., 1988; Carpenter, 2000), human resources (e.g. Kostiuk, 1990), management (e.g. Barkema and Gomez-Mejia, 1998), industrial relations (e.g. Agarwal, 1981) and sociology (e.g. Allen, 1981a) have published studies on the determinants and effects of executive compensation.

Members of the board of directors are charged with setting executive pay, and the way they compensate themselves may provide valuable information for understanding executive compensation (Yermack, 2004; Ryan and Wiggins, 2004) and other firm outcomes. Research on director pay is still in its infancy. Compared to the vast amount of research conducted on executive pay, academics have long shown relatively little interest in understanding how non-executive board members are getting paid and what effects their compensation has on the firm.

Complexity can be referred to as a state of being difficult to understand or explain because an entity has many different parts or sub-components. In the context of a corporation and its environment, complexity can arise from a variety of factors. Differing business segments and products, a firm’s organizational structure, various functional systems (e.g. HR systems, accounting systems), a multicultural workforce, different national regulations, the structure of product markets and supplier relationships, the differing demands of various stakeholder groups, a politicized environment or a high reliance on activities with an uncertain payoff such as research and development all are elements of a CEO’s job complexity.

The extant financial literature has typically examined compensation decisions from the perspective of a board of directors that attempts to establish an optimal contract in order to mitigate agency conflicts. Recent research, however, suggests that the process of determining compensation is better described as a negotiation between the board and the CEO and that the power of CEOs to influence boards provides an explanation for the lack of pay-performance sensitivity. For instance, Hermalin and Weisbach (1998) model a bargaining game in which the CEO’s compensation is negotiated between the two parties. Bebchuk et al. (2002) argue that the CEO’s power over the board of directors distorts optimal compensation contracts and that the existing empirical evidence better supports the bargaining model than the optimal contracting paradigm. In a large review of the executive pay literature Gomez-Mejia and Wiseman (1997: 320) suggest that “executive pay is a compromise between CEO power to inflate their compensation and societal pressures on boards to limit CEO pay” and that “the power of CEOs to influence boards provides a better explanation for the lack of pay-performance sensitivity than alternative explanations” (Gomez and Wiseman, 1997: 321).

The hypotheses have emerged out of a large-scale review of around 450 articles on executive compensation and related fields, review meetings with the referees of this dissertation and my work at the multinational corporation ABB . Working for the head of executive remuneration, I was involved in the design and development of a group-wide Employee Share Acquisition Plan ( ABB ESAP) at ABB Global Headquarters and the project manager for the implementation of this plan within ABB Australia . Among others, this job assignment enabled me to conduct interviews with experts in the field of executive remuneration, thus gaining a deeper understanding of the top management pay scene. I conducted interviews with Gary Steel, Head of HR, member of the Executive Committee and secretary to the Compensation Committee of ABB , David Tankel, Managing Director of London-based New Bridge Street Consultants and expert on executive remuneration, Hanspeter Fässler, member of the compensation committee of Daetwyler , and Prof. Dr. Rolf Dubs, chairman of the compensation committee of Schindler and member of the board of directors of Julius Bär . With the exception of the consultancy, all of these firms are included in my sample. Furthermore, I have gained insight into the processes and workings of top management teams in my current position as an assistant to the Executive Committee of ABB Switzerland Ltd , the ABB Group’s Swiss country organization employing 5, 000 employees. In this position, I have regularly attended top management and board of directors meetings.

Before turning to a detailed analysis of the influence of managerial power and complexity on executive compensation, I first examine the descriptive properties of executive compensation in Switzerland.

The basic discussion of results including a comparison with previous research was conducted in the results chapter, which also includes a sensitivity analysis. This chapter discusses additional topics in a more detailed manner.

This paper has broadened the usual empirical approach to the study of executive compensation. In the first place, a broad concept of complexity and power has been developed and their influence on executive compensation has been tested. Prior research has never tested how the concept of complexity influences compensation contracts despite strong theoretical ground and compensation consultants’ inclusion of complexity in job evaluation work. Suggested more than 15 years ago as a potentially important determinant of executive pay (Finkelstein and Hambrick, 1989), the complexity-pay relation has received very little attention ever since and operationalization of complexity has by and large been limited to single sources of complexity such as firm diversification (Finkelstein and Hambrick, 1989) and internationalization (Sanders and Carpenter, 1998). By building and testing a multidimensional framework of complexity, this work shows the large explanatory power of complexity in explaining top management pay levels and structure. Two of the analyzed dimensions of complexity - market uncertainty and politicized environment - have not received any attention in prior research. Although power has attracted much more attention from compensation researchers, empirical results are often inconsistent and ambiguous. Therefore, Finkelstein and Hambrick (1996) suggest that a formal test of the power hypothesis is needed, one that incorporates multiple aspects of executive power and allows for a more definitive statement about the effects of power on executive compensation. In this paper I have developed and tested a framework of executive power that incorporates multiple dimensions.