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An examination of pre-merger executive compensation structure in merging firms *.

In recent years, growth through acquisition has been an important strategy for many firms. While considerable attention has been devoted to merger valuation analysis, less consideration has been paid to successful integration of merging firms (Carey, 2000; Anonymous, 1999). Differences in culture, corporate philosophy, management style, corporate structure, and compensation are just a few of the important subjects to be reconciled. Much media attention has been given to the difficult issues of combining management and structuring executive compensation packages (Schellhardt, 1999). DeVoge and Shiraki (2000) suggest that issues involving employees are often the most poorly handled in mergers and acquisitions, and that this poor handling can create problems that may undermine the success of the merger. Yet, at the executive level, mergers can create problems due to uncertainties about job responsibilities, power sharing, and compensation. This study focuses on one of these important issues, namely compensation issues.

Recent merger activity has motivated considerable discussion of executive pay. In some cases, significant differences in pre-merger compensation structure and magnitude have raised interesting questions of firm compatibility. One recent example is the merger between Citicorp and Travelers Insurance. John S. Reed, CEO of Citicorp, and Sanford I.

Weill, CEO of Travelers, agreed to act as Co-Chairmen and Co-Chief Executive Officers for the new firm, Citigroup. Prior to the merger, Weill had substantially higher compensation than Reed. Media reports raised doubts that Weill and Reed could successfully integrate the two firms and predicted turf battles in the future (Dwyer, 1998). Anecdotal evidence suggests that retention issues may arise during acquisitions. In our sample, of the 1,612 executives listed in the proxy statement as top-five executives of the pre-merger acquiring firms, only 1,112 appear as one of the top-five executives after the merger. Furthermore, target-firm executives seldom appear in the top-five list after the merger. (1) Assuming the desire to retain top executives from both firms, at least in the short term to facilitate post-merger integration, large differences in total compensation may create challenges for the integration process. These challenges may be particularly important when the merger is outside the acquiring firms' c ore competencies and there is a critical need to retain target-firm executives for their expertise. In fact, Walsh (1988) suggests that a merger may be attractive due to the acquisition of target-firm management.

Acquiring and target firms can exhibit pre-merger differences in either levels of compensation or in compensation mix, including salary and performance-based components such as bonuses, restricted stock, long-term incentive plans, and stock options. The compensation disparities can be particularly troublesome if they impede integration of the two firms after the merger. Closing large pay gaps can begin to chip away at the merger's proposed savings. Alternatively, allowing large differences in compensation to continue after the merger can result in morale problems among members of the lower-paid executive team. Equity theory (Adams, 1963, 1965) suggests that when individuals perceive that large inequities in relationships with others exist, individuals feel distress and use various techniques to reduce that distress, including but not limited to, altering or terminating the relationship.

While research on executive compensation has increased dramatically in recent years, (2) research examining the relation between merger activity and compensation structure is limited. Two studies examine whether post-merger executive compensation is associated with post-merger firm financial performance. These studies find mixed results. Schmidt and Fowler (1990) find that post-merger compensation for acquiring firm executives does not relate to post-merger firm financial performance. However, Lambert and Larcker (1987) find that post-merger increases in executive compensation are associated with post-merger increases in shareholder wealth. Both studies limit their analysis to cash compensation. In contrast to these studies, our study, which includes both cash and equity-based compensation and is motivated by concerns that differences in those structures may affect successful integration of the merging firms, focuses on the pre-merger compensation structures of acquiring and target firms.

Successful merger integration requires an awareness of compensation disparities and thoughtful reconciliation of the pre-merger compensation structures of the merging firms. This study facilitates our understanding of these issues. In this study, we untangle the nuances of pre-merger compensation structure for a sample of firms involved in merger activity. Specifically, we examine and provide potential explanations for the pre-merger differences in acquiring- and target-firm compensation structures. Using executive compensation data from a sample of 321 mergers occurring from 1994 to 1996, we examine pre-merger executive compensation structures of acquiring and target firms. We document significant differences in executive compensation structures between acquiring and target firms before the merger. On average, executives in acquiring firms earn significantly greater total compensation than executives in target firms. In part, this difference is explained by pre-merger differences in firm size and growth oppo rtunities between acquiring and target firms. Prior to the merger, acquiring firms, on average, pay significantly higher salaries and award significantly higher annual bonuses, restricted stock, and other long-term incentive compensation, and grant stock options with significantly greater value than do target firms. Further, more acquiring firms than target firms award annual bonuses, restricted stock, other long-term incentive compensation, and stock options. While salary accounts for a larger proportion of the average executive's compensation in target firms, performance-based compensation such as bonuses and stock options account for a larger proportion of compensation in acquiring firms. In part, these differences are explained by pre-merger differences between acquiring and target firms in size and performance.

Notably, our models relating pre-merger differences in compensation to pre-merger differences in these well-documented determinants of compensation structure (i.e., size, growth opportunities, and performance) leave a significant portion of the difference in pre-merger compensation unexplained. Executives likely may understand pay differences attributable to these well-known factors. However, since these factors explain only a portion of the pre-merger compensation differences, it may well be the less obvious factors that create the greatest perceived inequities and thus the greatest integration challenges.

The remainder of this article is organized as follows. In the next section, we discuss recent merger activity and describe acquiring and target firms in our sample. Second, we examine pre-merger compensation structures of acquiring and target firms. Then, we discuss implications of our results. In the final section, we provide concluding remarks.

Recent Merger Activity

According to Securities Data Corporation's Mergers and Acquisitions database, during the 1994 to 1996 time period, there, were 5,587 mergers between U.S. firms. (3) From these 5,587 mergers, we eliminate 5,120 transactions for which either the acquiring or target firm is not publicly traded. We consider a firm to be publicly traded if it is included in the Compustat database. We also eliminate 121 transactions for which executive compensation data for either the acquiring or target firm is not available in the proxy statement, 10K, or annual report prior to the merger. Finally, we eliminate 25 transactions for which the acquiring or target firm has negative book value of equity. Our final sample consists of 321 transactions.

From the proxy statement, 10K, or annual report, we collect detailed data on executive compensation, including salary, bonus, other annual compensation, restricted stock, long-term incentive plans, stock options, and other compensation. (4) We use compensation data for the fiscal year prior to the effective date of the merger. However, for a few firms, due to data limitations, we use executive compensation data from an additional year earlier. We obtain financial data and SIC codes to construct variables representing firm size, growth opportunities, firm performance, and industry from the Compustat database.

Table 1 provides pre-merger financial data regarding sample firms. We find that prior to the merger, acquiring firms are significantly larger than target firms, with mean total assets of $8.5 billion compared to $2.0 billion for target firms (significant at [alpha] 0.01). In addition, our data suggest that target firms have significantly lower growth opportunities, as measured by market-to-book ratio (5), and significantly lower performance as measured by return on assets. Acquiring firms have a pre-merger mean market-to-book ratio of 3.01 compared to 2.48 for target firms (significant at < 0.05), and mean return on assets of 4.9% compared to 0.0% for target firms (significant at [alpha] < 0.01). Prior research has shown that these factors are important determinants of compensation structure (Balkin and Gomez-Mejia, 1987; Bizjak et al., 1993; Clinch, 1991; Gayer and Gayer, 1993; Gayer and Gayer, 1995; Kole, 1997; Lambert and Larcker, 1987; Smith and Watts, 1992).

Pre-Merger Compensation Structure

One key to successful integration of merging firms is to harmonize the two companies quickly (Carey, 2000). This principle is important for both the business aspects and the people-related aspects. It is critical to understand the people-related integration aspects before the merger to ensure that people maintain an external focus on the business, the customer, and the products rather than on their own internal issues. For top executives, uncertainties may include work relationships, job responsibilities, the balance of power, and concerns over turf battles. Compensation disparities can exacerbate these uncertainties. Failure to adequately address these disparities can lead to morale problems and the exodus of key executives. The success of the merger depends on the ability to resolve these internal issues, so that attention can be devoted to the external critical success factors for the merger or acquisition. To harmonize these compensation structures effectively, it is imperative to thoroughly understand th e disparities in the pre-merger compensation structures of the two firms.

Total Compensation

In the year prior to the merger, as shown in Table 2, mean total compensation per executive for acquiring firms is significantly larger than for target firms, with the average executive of acquiring firms earning $1,783,016, compared to $721,538 for the average executive of target firms (significant at [alpha] < 0.01). In addition, the average executive of acquiring firms receives significantly higher salary, bonus, restricted stock, awards under long-term incentive plans, and stock options than the average executive of target firms (significant at [alpha] < 0.01 for all compensation components).

Determinants of Pre-merger Differences in Total Compensation. As executives have more responsibility, they may command higher compensation. As firm size increases, executives have responsibility for managing an increasingly larger amount of assets and may, as a result, command higher compensation. In fact, Gaver and Gaver (1993) document a positive relation between size and cash compensation, and Smith and Watts (1992) document a positive relation between size and salary, their proxies for total executive compensation. As growth opportunities increase, executives have additional responsibility for selecting investment projects and, as a result, may command a higher total wage to compensate them for this additional responsibility. Gaver and Gaver (1993) and Smith and Watts (1992) find a positive relation between growth opportunities and executive compensation levels.

Agency theory suggests that managers are more risk-averse than owners and must be compensated for undertaking risky projects. Consistent with empirical evidence provided by Chung and Charoenwong (1991), growth firms tend to be riskier than non-growth firms, and managers require greater compensation for assuming this additional risk. Agency theory also suggests that managers' compensation should reflect firm performance. Prior research (e.g., Murphy, 1985; Smith and Watts, 1992; and Gayer and Gayer, 1993) finds that total compensation increases with firm performance.

Thus, theory predicts, and prior studies have shown, that size, growth opportunities, and performance are associated with total compensation. We conjecture that differences between acquiring and target firms in these three factors are important in explaining differences in pre-merger compensation between those firms.

We formed variables that represent the relative total compensation, size, growth opportunities, and performance between acquiring and target firms for each merger transaction. To examine characteristics that explain the difference in pre-merger total compensation in a multivariate setting, we estimated the following regression of relative total compensation on these variables representing relative size, growth opportunities, and performance using our sample of acquiring and target firms. In addition, we include an indicator variable to control for industry effects. (6)

REL_[TCOMP.sub.j] = [[alpha].sub.o], + [[alpha].sub.1] REL_[LASSET.sub.j] + [[alpha].sub.2] REL_M_[B.sub.j] + [[alpha].sub.3] REL_[ROA.sub.j] + [[alpha].sub.4] SAME_[IND.sub.j] + [[epsilon].sub.j] (1)

where variable definitions are as follows:

REL_[TCOMP.sub.j] = Natural log of Average Total Compensation per Executive for Acquirer / Average Total Compensation per Executive for Target in year prior to merger for transaction j (7)

REL_[LASSET.sub.j] = Natural log of Total Assets for Acquirer / Total Assets for Target in year prior to merger for transaction j

REL_M_[B.sub.j] = Market-to-book Ratio for Acquirer / Market-to-book Ratio for Target at end of year prior to merger for transaction j, where the market-to-book ratio is calculated as (Stock Price x

Number of Common Shares Outstanding) / Book Value of Equity

REL_[ROA.sub.j] = (Return on Assets for Acquirer - Return on Assets for Target) / Absolute Value of Return on Assets for Target in year prior to merger for transaction j, where return on assets is defined as net income / total assets

SAME_[JND.sub.j] = 1 if acquirer and target have same 3-digit SIC code in the year prior to the merger. and 0 otherwise

To avoid the influence of outliers, we winsorize observations for which the value of REL_TCOMP, REL_LASSET, and REL_M_B is above (below) the 95th (5th) percentile, and for which the value of REL_ROA is greater than (less than) 3.00 (-3.00). (8) Table 3 Panel A presents the Pearson correlations coefficients for variables in this regression.

Table 4 presents the results of estimating the model. Consistent with expectations, we find that differences in pre-merger size and growth opportunities between acquiring and target firms help explain differences in pre-merger total compensation (significant at [alpha] < 0.01). While firm performance might be expected to have an impact on compensation, we do not detect a relation between firm performance and total compensation.

Compensation Mix

In dealing with compensation inequities, an understanding of the mix of compensation may be important. For most firms, total executive compensation is comprised primarily of: (1) salary, (2) annual performance bonus, (3) restricted stock, (4) long-term incentive plan, and (5) stock options. As shown in Table 5, we find significant differences between pre-merger acquiring- and target-firm compensation mix. Consistent with arguments that risk-averse managers prefer some fixed compensation component (Murphy, 1999), all firms (100%) used a salary component in their compensation structure. Table 2 shows a mean salary of $336,088 for acquiring firms compared to $229,918 for target firms (significant at [alpha] < 0.01). Although acquiring firms' executives earn significantly more in salary dollars than the executives of the target firms, acquiring firms pay significantly less salary as a percentage of total compensation than the target firms. As shown in Table 5, Panel B, salary accounts for 55.4% of total compensat ion for the average executive of target firms compared to 37.6% for acquiring firms (significant at [alpha] < 0.01). As discussed below, this may reflect the fact that acquiring firms are larger and more financially sound.

Performance-based compensation is used more often among acquiring firms than target firms prior to the merger. Specifically, in Table 5, Panel A, we observe that in the year prior to the merger, 94.1% of acquiring firms award bonuses, 27.7% award restricted stock, 2 2.4% have payouts under long-term incentive plans, and 81.6% award stock options. This is significantly greater than the target firms, for which 82.2% award bonuses, 13.1% award restricted stock, 8.4% have payouts under long-term incentive plans, and 75.4% award stock options in the year prior to the merger (significant at [alpha] < 0.05 for each of these compensation components). Consistent with these relationships, as shown in Table 5, Panel B, the proportion of total compensation represented by each of these performance-based compensation components is significantly higher for acquiring firms than for target firms (significant at [alpha] < 0.01 for bonus, long-term incentive plan, stock options, and restricted stock).

Determinants of Pre-merger Differences in Compensation Mix. Agency theory suggests that when managerial effort is not observable, outcome measures may be informative about managers' actions (Jensen and Murphy, 1990). Oftentimes, firm performance is used as a proxy for managerial effort. Given that we can observe firm performance, incentive contracts can be developed to compensate the manager based on firm performance.

Size may proxy for the presence of agency issues. Because it is more difficult to observe managerial actions in large firms, large firms may face greater agency problems that call for the use of performance-based plans. In addition, large firms may be more likely than small firms to decentralize, thereby increasing the problem. Consistent with observing more incentive-based compensation in response to such agency costs, prior research documents a larger incidence of bonus and stock option plans in larger firms (Gaver and Gaver, 1993; Smith and Watts, 1992). Further, Gaver and Gaver (1995) document a larger proportion of compensation from long-term stock compensation and a smaller proportion of compensation from salary as firm size increases.

Growth opportunities also may proxy for agency issues. Smith and Watts (1992) suggest that managerial effort is less observable in firms with a higher proportion of value from growth opportunities than in firms with a higher proportion of value from assets in place. As a result, firms may be more likely to link compensation to the executive's impact on firm value through the use of incentive plans based on stock price. Further, risk-averse managers may require incentives to undertake riskier value-enhancing projects that are present in growth-opportunity firms. Myers (1977) suggests that stock-based compensation would be effective in motivating this behavior. Consistent with this argument, Smith and Watts (1992) and Gaver and Gaver (1993) find a higher incidence of stock option plans in firms with high growth opportunities. Further, Gaver and Gaver (1995) find that the proportion of compensation from salary decreases and the proportion of compensation from long-term compensation increases with higher growth o pportunities.

Finally, target firms have significantly lower performance than acquiring firms, with an average return on assets for target firms of 0.0% compared to 4.9% for acquiring firms (see Table 1). This performance differential is expected to result in the payout being lower under performance-based plans for target firms than for acquiring firms.

Thus, theory predicts, and prior studies have shown, that size, growth opportunities, and performance are associated with the use of performance-based compensation plans. We conjecture that differences in pre-merger compensation mix between acquiring and target firms can be explained by differences between the firms in these three factors.

We examined characteristics that explain the difference in pre-merger compensation mix between acquiring and target firms using variables representing relative size, growth opportunities, and performance. Using three dependent variables frequently observed as compensation components, we estimated the following regression for our sample of acquiring and target firms. In addition, we include an indicator variable to control for industry effects.

Compensation [variable.sub.j] = [[alpha].sub.0] + [[alpha].sub.1]

REL_[LASSET.sub.j] + [[alpha].sub.2] [REL_M_[B.sub.j] + [[alpha].sub.3]

REL_[ROA.sub.j] + [[alpha].sub.4] SAME_[IND.sub.j] + [[epsilon].sub.j] (2)

where variable definitions are as follows:

Dependent variables:

REL_[PSAL.sub.j]= Percent of Average Executive's Compensation from Salary for Acquirer / Percent of Average Executive's Compensation from Salary for Target in year prior to merger for transaction j

REL_[PBON.sub.j] = Percent of Average Executive's Compensation from Bonus for Acquirer / Percent of Average Executive's Compensation from Bonus for Target in year prior to merger for transaction j

REL_[PVOPT.sub.j] = Percent of Average Executive's Compensation from Stock Options for Acquirer / Percent of Average Executive's Compensation from Stock Options for Target in year prior to merger for transaction j

Independent variables:

REL_[LASSET.sub.j] = Natural log of Total Assets for Acquirer / Total Assets for Target in year prior to merger for transaction j

REL_M_[B.sub.j] Market-to-Book Ratio for Acquirer / Market-to-Book Ratio for Target at end of year prior to merger for transaction j, where the market-to-book ratio is calculated as (Stock Price x Number of Common Shares Outstanding) / Book Value of Equity

REL_[ROA.sub.j] = (Return on Assets for Acquirer - Return on Assets for Target) / Absolute Value of Return on Assets for Target in year prior to merger for transaction j, where return on assets is defined as net income / total assets

SAME_[IND.sub.j] = 1 if acquirer and target have same 3-digit SIC code in the year prior to the merger. and 0 otherwise

To avoid the influence of outliers, we winsorize observations for which the value of REL_TCOMP REL_LASSET, and REL_M_B is above (below) the 95th (5th) percentile, and for which the value of REL_ROA is greater than (less than) 3.00 (-3.00). (9) Table 3 Panel B presents the Pearson correlations coefficients for variables in these regressions.

Table 6 reports the results of estimating the above regressions. As expected, relative size between the acquiring and target firm is significant in explaining the relative proportion of compensation from salary, bonus, and options. Results suggest that large firms place more emphasis on performance-based compensation and less emphasis on fixed components to mitigate agency costs (significant at [alpha] < 0.10 in all regressions). Indeed, acquiring firms are, on average, larger than target firms. Our results suggest that as acquiring firms get larger relative to target firms, the emphasis placed on salary gets smaller and the emphasis placed on performance-based components gets larger relative to target firms.

Similarly, our results suggest that as acquiring firms get relatively more profitable, the emphasis placed on salary declines and the emphasis placed on bonuses increases relative to target firms (significant at [alpha] < 0.10 in regressions using PSAL and PBON). Given the long-term focus of stock options, it is not surprising that differences in emphasis on stock options are not related to differences in one-year ROA.

Contrary to expectations, we find no evidence that agency issues related to managing firms with high growth opportunities explain the differences in compensation mix between acquiring and target firms.

Discussion

As mentioned earlier, equity theory suggests that inequities in compensation can create significant distress for executives. Despite the likelihood that executives may understand pay differences that are explained by factors known to determine compensation levels, such as size, growth opportunities, and performance, differences attributable to these factors may pose integration challenges. However, it may be the differences in compensation levels not explained by these well-documented factors that create the greatest perceptions of inequities. Interestingly, our model examining the relation between relative size, growth opportunities, and performance and relative total compensation (Table 4) explains only 32% (adjusted [R.sup.2]) of the variation in relative total compensation prior to the merger. Similarly, our models examining the relation between these three factors and the relative proportion of compensation from salary, bonus, and stock options (Table 6) explains even less (adjusted [R.sup.2] of 9%, 6%, and 1%, respectively) of the variation. This suggests that there is a significant amount of this variation that is explained by factors other than these well-documented determinants of compensation. Future research can shed light on these unexplained factors and on the methods that merging firms use to reconcile the differences in pre-merger compensation.

Conclusion

Successful merger integration can be critical to creating the anticipated added value from a merger. The newly merged firm faces internal challenges as it attempts to move forward with the new firm. The compensation structure, including the level of compensation and compensation mix, is an important issue to be resolved. In this study, we use executive compensation data from a sample of 321 mergers occurring from 1994 to 1996 to describe the pre-merger differences in acquiring- and target-firm compensation structures, provide explanations for these differences, and discuss implications of these disparities for merger integration.

We observe significant differences in acquiring- and target-firms' compensation structures prior to the merger. On average, total compensation is significantly higher for executives in acquiring firms than target firms. Differences in pre-merger size and growth opportunities between the acquiring and target firms in part explain this difference. In addition, executives in acquiring firms earn higher salaries, receive higher bonuses, restricted stock, and other long-term incentive compensation, and are granted stock options with greater value than executives in target firms. Furthermore, more acquiring firms than target firms use performance-based compensation such as bonuses and stock-based compensation such as restricted stock and stock options. Consistent with this observation, salary accounts for a larger portion of the average executive's compensation in target firms, and performance-based and stock-based compensation accounts for a larger portion of the average executive's compensation in acquiring firms . We find that these differences in compensation mix are explained only partially by differences in pre-merger size and performance between acquiring and target firms.

Most importantly, our models relating compensation level and compensation mix to well-documented determinants of compensation structure explain only a portion of the differences in pre-merger compensation structure. This suggests that there is a significant amount of this variation that is explained by factors other than these well-documented determinants of compensation. It may be these other factors create the most integration challenges. As mentioned earlier, equity theory suggests that inequities in compensation could create significant distress for executives. It is possible that executives understand pay differences that are explained by factors known to determine compensation levels, such as responsibility, risk, and performance. However, it may be the differences in compensation levels not explained by these factors create the greatest perceptions of inequities and thus the greatest challenges to integration.

Failure to reconcile these differences can lead to morale and turnover issues that can lessen possible integration success. In extreme circumstances, integration issues resulting from these disparities can stand in the way of achieving the expected benefits that originally led to the merger. Reconciling the differences will present large challenges for the combined company. Little is known about the optimal method to use and timing over which to close the gap in compensation between acquiring- and target-firm managers. Such questions are productive avenues for future research.
TABLE 1

Descriptive Statistics of Acquiring and Target Firms

 Acquiring firms Target firms
 (321 firms) (a) (321 firms) (a)

Total Assets ($ 000) $ 8,492,805 $ 2,018,556
 ($ 1,773,700) ($ 254,042)

Market to Book Ratio 3.01 2.48
 (2.31) (1.70)

Return on Assets 4.9% 0.0%
 (4.7%) (2.8%)

Average Total $ 1,783,016 $ 721,538
Compensation per ($ 1,101,409) ($396,599)
Executive

 t-statistics
 (z-statistic) (b)

Total Assets ($ 000) 5.48 ***
 (8.45) ***

Market to Book Ratio 2.22 **
 (5.20) ***

Return on Assets 4.69 ***
 (3.88) ***

Average Total 8.28 ***
Compensation per (9.32) ***
Executive

*** (**)Significant at less than 0.01 (0.05), two-tailed test.

(a)Means are reported, with medians in parentheses.

(b)Two-tailed t-test of difference in means (Wilcoxon signed rank test
of difference in medians).

Variable definitions

Total Assets = Total Assets from Compustat (data item 6)

Market-to-Book Ratio = (Shares outstanding x Closing Price)/Book Value
of Equity (Compustat data items (25 x 24)/60)

Return on Assets = Income Before Extraordinary Items/Total Assets
(compustat data items 18/6)

Total compensation = Salary + Bonus + Other Annual Compensation +
Restricted Stock + Longterm Incentive Plan + Value of Options Granted +
Other Compensation, each as reported in firm's prexy statement. Average
total compensation per executive is calculated for the firm's top five
executives as reported in the proxy statement.
TABLE 2

Pre-merger Compensation Levels of Acquiring and Target Firms Average $
per Executive for Various Compensation Components

 Acquiring firms Target firms
 (321 firms) (a) (321 firms) (a)

Total compensation (c) $ 1,783,016 $ 721,538
 ($ 1,101,409) ($396,599)

Salary $ 336,088 $ 229,918
 ($ 293,402) ($ 191,480)

Bonus $ 352,436 $ 100,953
 ($ 193,083) ($ 46,800)

Other annual $36,382 $ 16,023
compensation ($ 0) ($ 0)

Restricted stock $ 92,557 $ 29,010
 ($0) ($0)

Long-term incentive $76,477 $ 15,250
plan ($0) ($0)

Options $ 827,964 $ 282,248
 ($ 319,276) ($ 62,308)

Other compensation $ 53,466 $ 47,695
 ($ 13,290) ($ 8,146)

 t-statistic
 (z-statistic) (b)

Total compensation (c) 8.28 ***
 (9.32) ***

Salary 9.23 ***
 (8.75) ***

Bonus 6.98 ***
 (10.96) ***

Other annual 1.84 *
compensation (1.29)

Restricted stock 3.60 ***
 (4.60) ***

Long-term incentive 3.82 ***
plan (4.90) ***

Options 5.94 ***
 (7.11) ***

Other compensation 0.36
 (3.39) ***

*** (*) Significant at less than 0.01 (0.10), two-tailed test.

(a)Means are reported, with medians in parentheses.

(b)Two-tailed t-test of difference in means (Wilcoxon signed rank test
of difference in medians).

(c)Total compensation = Salary + Bonus + Other Annual Compensation +
Restricted Stock + Longterm Incentive Plan + Value of Options Granted +
Other Compensation, each as reported in firm's proxy statement. Average
total Compensation per execuive is calculated for the firm's top tive
executives as reported in the proxy statement.
TABLE 3

Pearson Correlation Coefficients

Panel A: Pearson correlation coefficients for variables in regression 1

 REL_TCOMP REL_LASSET REL_M_B REL_ROA

REL_LASSET 0.54
REL_M_B 0.15 -0.05
REL_ROA 0.07 -0.04 0.30
SAME_IND -0.09 -0.18 0.00 0.09
Panel B: Pearson correlation coefficients for variables in regression?

 REL_PSAL REL_PBON REL_PVOPT REL_LASSET REL_M_B REL_ROA

REL-PBON -0.06
REL_PVOPT -0.51 -0.32
REL_LASSET -0.29 0.08 0.16
REL_M_B 0.04 0.11 0.07 -0.05
REL_ROA -0.07 0.22 0.01 -0.04 0.30
REL_IND -0.10 0.11 -0.09 -0.18 0.00 0.09
TABLE 4

Regression of Relative Total Compensation on Variables Representing
Relative Size, Relative Growth Opportunities, Relative Performance, and
Relative Industry

 REL_TCOMP (a)
 N= 253 (a)

Intercept -0.03
 (-0.23)

REL_LASSET 0.37 ***
 (10.37)

REL_M_B 0.16 ***
 (2.90)

REL_ROA 0.05
 (1.26)

SAME_IND -0.04
 (-0.39)

Adj. [R.sup.2] 0.32


*** Significant at less than 0.01, two-tailed test.

(a)t-statistics in parentheses

Variable definitions:

REL_TCOMP = Natural Log of (Average Total Compensation per Executive for
Acquirer / Average Total Compensation per Executive for Target) in year
prior to merger

REL_LASSET = Natural Log of (Total Assets for Acquirer / Total Assets
for Target) in year prior to merger

REL_M_B = Year-end Market-to-Book Ratio for Acquirer / Year-end
Market-to-Book Ratio for Target in year prior to merger

REL_ROA = (Return on Assets for Acquirer - Return on Assets for Target)
/ Absolute Value of Return on Assets for Target in year prior to merger,
where return on assets = Net income / Total assets

SAME_IND = 1 if acquirer and target have same 3-digit SIC code in year
prior to merger, 0 otherwise
TABLE 5

Pre-merger Compensation Mix of Acquiring and Target Firms

Panel A: Use of compensation components: percent of firms using various
components

 Acquiring firms Target firms
 (321 firms) (a) (321 firms) (a)

Salary 100.0% 100.0%
Bonus 94.1% 82.2%
Other annual compensation 41.4% 36.4%
Restricted stock 27.7% 13.1%
Long-term incentive plan 22.4% 8.4%
Options 81.6% 75.4%
Other compensation 86.0% 81.9%

 t-statistic
 (z-statistic) (b)

Salary 0.00
Bonus 4.71 ***
Other annual compensation 1.29
Restricted stock 4.67 ***
Long-term incentive plan 4.99 ***
Options 1.92 **
Other compensation 1.40
Panel B: Compensation mix: average % of exec's compensation from various
alternatives

 Acquiring firms Target firms
 (321 firms) (a) (321 firms) (a)

Salary 37.6% 55.4%
 (33.9%) (54.3%)

Bonus 20.4% 13.8%
 (19.6%) (11.0%)

Other annual compensation 1.7% 2.0%
 (0.0%) (0.0%)

Restricted stock 3.3% 1.9%
 (0.0%) (0.0%)

Long-term incentive plan 3.3% 1.2%
 (0.0%) (0.0%)

Options 30.4% 21.4%
 (29.6%) (15.7%)

Other compensation 3.3% 4.3%
 (1.5%) (1.7%)

 t-statistic
 (z-statistic) (b)

Salary -10.03 ***
 (-8.51) ***

Bonus 6.17 ***
 (6.66) ***

Other annual compensation -0.52
 (1.12)

Restricted stock 2.59 ***
 (4.39) ***

Long-term incentive plan 3.78 ***
 (4.87) ***

Options 4.86 ***
 (5.52) ***

Other compensation -1.81 *
 (-0.77)

*** (**) (*) Significant at less than 0.01 (0.05) (0.10), two-tailed
test.

(a) Means are reported, with medians in parentheses.

(b) Two-tailed t-test of difference in means (Wilcoxon signed rank test
of difference in medians).
TABLE 6

Regression of Variables Representing Relative Compensation Mix on
Variables Representing Relative Size, Relative Growth Opportunities,
Relative Performance, and Relative Industry

 Dependent Variable (a)
 REL_PSAL REL_PBON REL_PVOPT
 n = 253 n = 203 n = 172

Intercept 1.08 *** 1.01 *** 0.97 **
 (10.93) (4.98) (4.29)
REL_LASSET -0.12 *** 0.10 * 0.11 **
 (-4.82) (1.86) (2.00)
REL_M_B -0.03 0.08 0.07
 (-0.67) (0.92) (0.82)
REL_ROA -0.05 * 0.16 *** 0.01
 (-1.84) (2.95) (0.15)
SAME_IND 0.01 0.28 * -0.19
 (0.19) (1.91) (-1.11)
Adj. [R.sup.2] 0.09 0.06 0.01

*** (**) (*) Significant at less than 0.01 (0.05) (0.10), two-tailed
test.

(a)s-statistics in parentheses

Variable definitions:

REL_PSAL = Percent of Average Executive's Compensation from Salary for
Acquirer/Percent of Average Executive's Compensation from Salary for
Target in year prior to merger

REL_PBON = Percent of Average Executive's Compensation from Bonus for
Acquirer/Percent of Average Executive's Compensation from Bonus for
Target in year prior to merger

REL_PVOPT = Percent of Average Executive's Compensation from Options
Granted for Acquirer/Percent of Average Executive's Compensation from
Options Granted for Target in year prior to merger

REL_LASSET = Natural Log of (Total Assets for Acquirer/Total Assets for
Target) in year prior to merger

REL_M_B = Year-end Market-to-Book Ratio for Acquirer/Year-end
Market-to-Book Ratio for Target in year prior to merger

REL_ROA = (Return on Assets for Acquirer - Return on Assets for
Target)/Absolute Value of Return on Assets for Target in year prior to
merger, where rerurn on assets = Net income/Total assets

SAME_IND = 1 if acquirer and target have same 3-digit SIC code in year
prior to merger, 0 otherwise


* Luanne Lynch gratefully acknowledges the financial support by the University of Virginia Darden School Foundation. Susan Perry gratefully acknowledges the financial support provided by the University of Virginia McIntire School of Commerce. We appreciate the helpful comments and suggestions by Charles Fischer, two anonymous referees, and Tom Williams. We would like to thank Adam Rennhoff and Sherika Charity for assistance in data collection.

(1.) Caution is warranted in interpreting these statistics as perfect indicators of executive turnover. Since the list presented in the proxy statement is limited to the CEO and the four most highly paid executives earning greater than $100,000, it is possible that an executive fails to appear on the list because his or her pay is surpassed by that of another executive.

(2.) See Murphy (1999) for an excellent review of executive compensation research.

(3.) These are transactions in the SDC Mergers and Acquisitions database with a merger code of "m," and are transactions for which the bidder holds less than 50% and seeks to acquire 100% of the target.

(4.) The SEC requires that firms provide in their proxy statement detailed compensation data for the CEO and the other 4 highest paid executives earning greater than $100,000. In a limited number of cases, firms report these data for more or fewer than five executives.

(5.) Consistent with Smith and Watts (1992) and Gayer and Gayer (1993, 1995), among others, we use the market-to-book ratio as a proxy for growth opportunities. A higher market-to-book ratio signifies higher growth opportunities.

(6.) Results from prior research on the effects of industry on compensation structure are mixed (Finkelstein and Boyd, 1998; Murphy, 1999; Rosen, 1982).

(7.) Consistent with Gaver and Gaver (1993), Murphy (1999), and Smith and Watts (1992), we use the natural log of total compensation and total assets.

(8.) We tested for heteroscedasticity using a procedure from White (1980) and were unable to reject the null hypothesis of homoscedasticity.

(9.) We tested for heteroscedasticity using a procedure from White (1980) and were unable to reject the nully hypothesis of homoscedasticity.

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