Asymmetries in Dynamic CEO Compensation

Abstract

In this study we test the null hypothesis of symmetry in contemporaneous and long-run responses of CEO cash and total compensation to stock and accounting returns. Over the long run, we find that cumulative cash and total compensation responses are concave in stock returns (i.e., are more sensitive to stock returns when company performance is poor). Although prior research has documented concavity in contemporaneous cash compensation (Leone et al. 2006), we find that the majority of the asymmetry for cash compensation, and virtually all of the asymmetry for total compensation, occur after the contemporaneous period. Prior research (e.g., Shaw and Zhang 2010) has also documented that contemporaneous cash compensation is convex in accounting returns (i.e., less sensitive to accounting returns when company performance is poor). We also find contemporaneous convexity for cash (and for total) compensation, but this convexity reverses over time, such that the long-run cumulative cash and total compensation responses are directionally, but not significantly, concave in accounting returns. Our findings of concavity are consistent with “prudent” boards of directors steering CEOs away from downside risk via their long-run compensation contracts. Our weaker results for accounting returns are consistent with a substitution of accounting conservatism for concavity in pay arrangements. However, our long-run results are not consistent with CEO cash or total pay being shielded from the effects of poor outcomes in either stock or accounting performance.