Spillover effects in managerial compensation

Abstract

Prior evidence on how executive compensation influences managerial incentives to take risks in shareholder’s interest ignores potential spillover effects, even though there is evidence that compensation in one firm affects the compensation in other firms. We address this issue in a way that considers a broader view of corporate networks. Specifically, we examine the effects of a tax law change that induced a change in the vega of CEO compensation. We find that this change is associated with a larger increase in the vegas of directly affected CEOs than would be estimated without considering spillover effects. Moreover, we find evidence for the diffusion of these changes to other firms within their industry. Further, this diffusion is greater the more affected firms within an industry. And finally, we find that these changes are associated with increases in the asset volatility of both treated and untreated firms.