Information Technology Investments, CEO Compensation and Market Valuation

Abstract

Managers face tradeoffs. On one hand, CEOs make IT spending decisions in anticipation of generating competitive advantages and productivity improvements. On the other hand, CEOs realize the risky nature of IT spending and its immediate negative effect on current income. Boards of directors, recognizing the potential long-term contribution of IT to firm value, should thus structure its CEO compensation packages to encourage strategic IT spending. To test this proposition, we examine the relation between IT spending and various components of CEO compensation and assess its impact on firm value. Our empirical results suggest that IT spending is positively related to ratio of equity to total CEO compensation. This result is consistent with the notion that boards of directors understand that payoffs to IT are uncertain and, hence, tie CEO compensation to the long-term results by placing greater weight on equity compensation. Furthermore, we find that boards of directors shield CEOs' cash compensation from the earnings decreasing effects of IT expense to mitigate potential underinvestment in IT. Finally, we conclude that the synergistic relationship between IT spending and CEO equity compensation is positively associated with firm market value. Bridging the two research streams of business value of IT and CEO compensation, our study contributes to the literature by examining how ties between IT and CEO compensation contracts impact firm value.