Managerial Attributes, Incentives, and Performance

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This paper examines the relative importance of observed and unobserved firm- and manager-specific heterogeneities in determining the primary aspects of contract design and the implications of thee associated incentives for firm policy, risk, and performance. We focus on the sensitivity of managerial wealth to stock price (delta) and the sensitivity of expected managerial wealth to stock volatility (vega) for named executive officers. First, following Graham, Li, and Qiu (2010), who apply the econometric approach of Abowd, Karmarz, and Margolis (1999) to executive pay level, we decompose the variation in executive incentives into time variant and invariant firm and manager components. We find that manager fixed effects and observable firm attributes combined supply 80-90% of explained variation in managerial delta and vega. Second, accommodating unobserved firm and manager heterogeneity and controlling for matching of executives to firms alters parameter estimates and corresponding inference on observed firm and manager characteristics, most notably board independence, firm risk, and market-to-book. Third, we explore the economic content of the estimated executive delta and vega fixed effects. There is a strong empirical association between the executive delta and vega fixed effects and attributes of managers and firms that are seen to proxy for manager human capital and risk aversion and firm marginal revenue product in application of manager skill. Moreover, larger CEO delta fixed effects are associated with higher Tobin’s Q and ROA. Larger CEO vega fixed effects are associated with riskier corporate policies, including higher R&D, lower capital expenditures, and lower fixed assets, as well as higher aggregate firm risk.