The Role of the Executive Pay Cap: Evidence from Korea

Korean firms are required to obtain shareholder approval on their executive pay cap—the maximum possible amount of total compensation for all executives. This paper investigates the efficacy of the executive pay cap requirement by analyzing the determinants and implications of the executive pay cap of Korean firms. We document that the executive pay cap is not a boilerplate figure and is associated with corporate governance and economic factors. We find that the executive pay cap is adjusted according to changes in firm performance and that a significant portion of sample firms revise their executive pay cap downwards. However, we only observe this phenomenon when foreign ownership is high, largest shareholders’ ownership is high, a controlling shareholder is a board member, and the firm is a non-chaebol firm. Thus, we find that the external and internal monitoring mechanisms affect whether the executive pay cap is better aligned with firm performance. Our results also suggest that the executive pay cap is used as an anchor for determining executive compensation. We do not find support for the alternative possibility that firms could signal future firm performance through the executive pay cap.