Executive Compensation and Horizon Incentives: An Empirical Investigation of Corporate Cash Payout

Abstract

The recent financial crisis has renewed the interest in executives’ compensation-related horizon incentives. This paper examines how the short-termism in CEO compensation affects corporate cash payout through share repurchases using a new measure of compensation horizon incentive. In contrast to the conventional wisdom that firms buy back shares after poor stock performance, we find that CEOs with short compensation horizons are more likely to buy back shares after good performance. To bolster already high stock price, they have incentives to repurchase to boost up reported EPS towards analysts’ expectations, and to cater to investors with short investment horizons. This short-termism is not related to corporate governance, but is more severe in firms that have less liquid stocks. While long-term shareholders do not benefit from such repurchases, short-termist CEOs benefit by selling their own holdings when firms are buying. Our findings suggest that some large cash payouts by firms with short managerial horizons during the repurchase binge in 2005-2008 may be premature, which portraits a striking contrast from the liquidity constraints that many firms experienced later during the crisis. ∗ I thank Long Chen, Jie Gan, Radha Gopalan, Vidhan Goyal, Paul Malatesta, and seminar participants in Singapore Management University for their helpful comments. Author contacts: Lee Kong Chian School of Business, Singapore Management University, 50 Stamford Road, Singapore 178899. Email: shenghuang@smu.edu.sg. Tel: (65) 68280252