How CEOs inflate their salaries

If you have a strong network of business colleagues who sit on each other's board, your pay can be a lot heftier - but often at the expense of your shareholders, according to a new study by the Ted Rogers School of Management at Ryerson University and the University of Toronto's Rotman School of Management.

The researchers were interested in testing the theory that business executives, who have strong networks among their peers, are more likely to inflate their colleagues' pay because they believe it will be reciprocated.

"There's a great deal of research trying to understand how a chief executive officer's pay is determined," said study's co-lead author professor Fei Song from the Ryerson University, Toronto.

"One school of thought is that their pay is determined by a corporation's board of directors," Song explained.

"However, people who make up these boards are often CEOs of other companies themselves and are more likely to receive higher compensation packages because of this exclusive network," Song added.

But what happens when CEOs are paid more?

"If executives of corporations receive a higher compensation, they may be taking the company's revenue from the shareholders' pockets and paying it to themselves," Song added.

Indirectly reciprocal networks are often overlooked and difficult to track, the study said.

"Imagine three CEOs from companies A, B, and C where A sits on B's board, B sits on C's board, and C in turn sits on A's board."

"In this example, there is no direct conflict of interest because A does not benefit him or herself by inflating B's salary and the same applies to the other two CEOs," said co-author professor Zhong from the University of Toronto.

"Nevertheless, our findings suggest that everyone in the network is likely to inflate salary for each other. Now imagine this network consists of hundreds of CEOs," Zhong said.

While it is difficult for shareholders to see the circle of reciprocity among CEOs, "as a start, giving shareholders more powers to monitor board meetings would help", the researchers said.