CEO Skills Research Articles

ESG-Linked Compensation, CEO Skills, and Shareholder Welfare

Abstract Executive compensation is increasingly being linked to ESG outcomes. This paper examines whether ESG targets are consistent with shareholder welfare. Using granular information on compensation contracts of Swedish CEOs, we show that ESG and financial targets are competing. ESG-linked compensation is 5 percentage points more common in well-governed firms and 6.3 percentage points more likely for CEOs with broader skill sets (generalist CEOs). ESG scores of well-governed firms improve when generalist CEOs have ESG-linked pay, but there is no effect on profitability. These results suggest that boards set ESG contracts because shareholders derive utility from ESG in addition to wealth, and ESG may not be produced without these incentives. (JEL M14, G14, D21, L21) Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.

CEO Skills in Preventing Tax Avoidance Activities and Reducing the Risk of Stock Price Crashes in Indonesia

The market bubble phenomenon has hit the capital markets, including in Indonesia. This occurs when a company’s cash flow is lower than investors’ expectations. Even the literature on stock price crash risk, which considers managers’ motives to disguise negative information, identifies that tax avoidance has been used as a mask by managers to cover up poor performance. This study aims to determine the effect of high CEO capability on the relationship between tax avoidance and stock price crash risk in Indonesia. This research method uses a quantitative approach with 436 observations of companies on the Indonesia Stock Exchange during the period 2015–2019. Data was obtained through the official website of the Indonesia Stock Exchange indexed by Kompas 100. The data was tested using ordinary least squares regression model. The results of this study found that, first, tax evasion has a positive effect on the risk of decreasing the share price of companies incorporated in the Kompas 100 index on the Indonesia Stock Exchange. Second, that a highly skilled CEO can weaken the relationship between tax evasion and the risk of falling stock prices. This finding supports the agency theory perspective, where tax evasion is used by opportunistic managers to disguise financial information, thereby increasing the risk of future stock price crash. This study enriches the literature by demonstrating the role of highly skilled CEOs in influencing the intensity of the relationship between tax avoidance and stock price crash risk. Second, this study demonstrates the uniqueness of incorporating the human aspect, in the form of CEO characteristics, into the model linking tax avoidance with stock price crash risk.

CEOs' general managerial skills and corporate risk taking subject to the moderator of CEO tenure

AbstractIn this study, we examine the relation between chief executive officers' (CEOs') general managerial skills and firms' risk‐taking behaviour. We find that generalist CEOs are associated with significantly higher firm risk, with the association decreasing significantly with CEO tenure. We propose the following managerial skills transformation explanation: the longer a CEO stays with a firm, the less general and more firm specific the CEO's skills and knowledge become; therefore, any effect of the CEO's general managerial skills only appears in the early years of tenure.

ESG-Linked Compensation, CEO Skills, and Shareholders’ Welfare

ESG-Linked Compensation, CEO Skills, and Shareholders’ Welfare

The Market for CEOS: Building Legacy and Feeling Empowered Matter

We develop a two-sided multidimensional matching model of the market for CEOs that allows for both pecuniary and non-pecuniary (amenity) compensation. The model is estimated by maximum likelihood estimation using matched CEO-firm data from Denmark. We show that CEOs have preferences for building legacy and gaining empowerment. The legacy mechanism explains why there is low mobility in the CEO market, even though firms demand general CEO skills. The empowerment mechanism explains why CEOs are willing to sacrifice significant pecuniary income to manage high equity firms. The overall conclusion is that job amenities matter in the market for CEOs.

Auditor's expertise and the effect of the European banking sector CEO skill on audit quality during the European financial crisis

The paper examines whether Eurozone banks that replace their CEOs with highly skilled ones, also switch to industry-expert auditors, thereby increasing the quality of auditing they receive. Using a sample of Eurozone banks, we develop a logistic regression model that incorporates auditor expertise as an audit quality determinant, audit opinion and directorship skill. Moreover, various proxies are used to control for the effect on the type of auditor opinion. The findings indicate that Eurozone banks alter their approach regarding auditor choice, after replacing their CEO with one with a higher level of directorship skill. Moreover, they seem to switch towards auditors specialising in the sector, thus increasing the quality of auditing, but only if they operate in a country facing fiscal sustainability issues. Robustness checks of the results are assertive of the validity of the conclusions reached. There are important implications arising from the study, highlighting that greater managerial performance is not necessarily reflective of financial health and stability. In fact, banks operating in a harsh financial environment may seek additional reassurance by establishing a higher quality of audit.

Auditors expertise and the effect of the European banking sector CEO skill on audit quality during the European financial crisis

The paper examines whether Eurozone banks that replace their CEOs with highly skilled ones, also switch to industry-expert auditors, thereby increasing the quality of auditing they receive. Using a...

Directors skill and financial reporting quality

AbstractMotivated by theoretical models in economics which show that there is matching between CEO skill and firm size, we introduce a new measure of director skill which is based on the aggregate size of firms on which the director serves as an independent director. We validate our measure by showing that it is positively associated with director experience, financial expertise, industry expertise and managerial experience. We then examine whether our average measure of skill across board members is positively associated with monitoring quality. Controlling for the endogenous relationships between board composition and financial reporting quality, we find a positive association between our board measure for skill and monitoring quality, and we show that directors have a causal impact on monitoring effort and outcomes. Furthermore, consistent with the enhanced monitoring provided by skilled directors, we document a positive association between the level of and changes in our measure and firm value.

'I Meant to Do That': Evaluating Luck versus Skill in Firm Performance

This study is an empirical examination of the extent to which either managerial skill or random external influences — i.e., luck — are responsible for firm performance. To adjudicate between the respective theoretical claims, we examine how much of the observed cross-sectional dispersion of outcomes can be attributed to differences in luck rather than differences in skill. Using a unique empirical strategy of bootstrap simulations that we compare to the observed results of public companies, we demonstrate that a substantial portion of performance variation depends on random influences rather than on managerial skill. Specifically, our results show that we can expect to observe substantial differences in realized (i.e., actual) performance outcomes even if all CEOs in a given sample are equally skilled, thus suggesting that the true underlying differences in CEO skill are substantially smaller than implied by simply looking at the raw difference in performance outcomes. Our results not only assist researchers in interpreting firm outcomes but also inform ideas of executive pay and responsibility.

CEO Investment Cycles

This paper documents the existence of a CEO Investment Cycle, in which firms disinvest early in a CEO’s tenure and increase investment subsequently, leading to “cyclical” firm growth in assets as well as in employment over CEO tenure. The CEO investment cycle occurs for both firings and non-performance related CEO turnovers, and for CEOs with different relationships with the firm prior to becoming CEO. The magnitude of the CEO cycle is substantial: The estimated difference in investment rate between the first three years of a CEO’s tenure and subsequent years is approximately 6 to 8 percentage points, which is of the same order of magnitude as the differences caused by other factors known to affect investment, such as business cycles or financial constraints. We present a variety of tests suggesting that this investment cycle is best explained by a combination of agency-based theories: Early in his tenure the CEO disinvests poorly performing assets that his predecessor established and was unwilling to give up on. Subsequently, the CEO overinvests when he gains more control over his board. There is no evidence that the investment cycles occur because of shifting CEO skill or productivity shocks. Overall, the results imply that public corporations’ investments deviate substantially from the first-best, and that governancerelated factors internal to the firm are as important as economy-wide factors in explaining firms’ investments.

Which Skills Matter in the Market for CEOs? Evidence from Pay for CEO Credentials

Market-based theories predict that differences in CEO skills lead to potentially large differences in pay, but it is challenging to quantify the CEO skill premium in pay. In a first step toward overcoming this empirical challenge, we code detailed biographical information for a large sample of CEOs for a panel of S&P 1500 firms between 1993 and 2005 to identify specific reputational, career, and educational credentials that are indicative of skills. Newly appointed CEOs earn up to a 5% or $280,000 total pay premium per credential decile, which is concentrated among CEOs with better reputational and career credentials, those with the very best credentials, and those who run large firms. Consistent with the unique economic mechanism of market-based theories, CEO credentials have a positive impact on firm performance. The performance differential for newly appointed CEOs is up to 0.5% per credential decile and is also concentrated among CEOs with better reputational and career credentials and those at large firms. Credentials are positively correlated with unobserved CEO heterogeneity in pay and performance, which further validates our hypothesis that boards use them as publicly observable signals of otherwise hard-to-gauge CEO skills. In all, our results offer direct evidence in support of market-based explanations of the overall rise in CEO pay.This paper was accepted by Itay Goldstein, finance.

Competition for Talent Under Performance Manipulation: CEOs on Steroids

We study how competition for talent affects CEO compensation, taking into consideration that CEO decisions and CEO skills or talent are not observable, and CEOs can manipulate performance as measured by outsiders. Firms compete by offering contracts that generate rents for the CEO. We derive the equilibrium compensation contract, and we describe how competition changes that contract and the outcome. Intuitively, competition increases realized CEO compensation. It also strengthens the incentive power of the contracts. While competition mitigates inefficiencies caused in its absence, it also generates inefficiencies of its own. Competition replaces a downward distortion by an upwards distortion (incentive power is excessively strong), and it switches the focus of equilibrium effort distortions from low-talent CEOs to high-talent CEOs. Competition leads to higher effort but also to more manipulation of measured performance. If the cost of manipulating performance is low, the distortions can outweigh those that are mitigated, and competition for talent may reduce the overall surplus. We discuss possible remedies, including regulatory limits to incentive compensation.

The salaries of CEOs: Is it all about skills?

This research identifies mechanisms that could help achieve a deeper understanding of the abnormal compensation of CEOs. We construct a model in which the determination of compensation depends on three factors: the CEO's skills, the level of competition in the sector and the ownership structure of the firm. The model allows us to break down the components of the CEO's compensation into talent, and abnormal compensation justified by the level of competition and ownership structure. Furthermore, it facilitates breaking down the abnormal compensation into endogenous premium stemming from change in the CEO's effort, and net abnormal compensation. Breaking down the compensation into different components is crucial for establishing efficient tax or other socio-economic policies. Taxing compensation that is an outcome of talent and effort might result in relatively high economic burden, however taxing the net abnormal return would create almost no economic burden.

Multi-board Directors, Board Reputation, and Financial Reporting Quality

Motivated by theoretical models in economics which show that there is matching between CEO skill and firm size, we introduce a new measure of director skill which is based on the aggregate size of firms on which the director serves as an independent director. We validate our measure by showing that it is positively associated with director experience, financial expertise, industry expertise, and managerial experience. We then examine whether our average measure of skill across board members is positively associated with monitoring quality. Controlling for the endogenous relation between board composition and financial reporting quality, we find a positive association between our board measure for skill and monitoring quality, and we show that directors have a causal impact on monitoring effort and outcomes. Furthermore, consistent with the enhanced monitoring provided by skilled directors, we document a positive association between the level of and changes in our measure and firm value.

To Each According to His Ability? CEO Pay and the Market for CEOs

Market-based theories predict that differences in CEO skills lead to potentially large differences in pay, but it is challenging to quantify the CEO skill premium in pay. In a first step toward overcoming this empirical challenge, we code detailed biographical information on a large sample of CEOs for a panel of S&P 1,500 firms between 1993 and 2005 to identify specific reputational, career, and educational credentials that are indicative of skills. Newly-appointed CEOs earn up to a 5% or $280,000 total pay premium per credential decile, which is concentrated among CEOs with better reputational and carreer credentials, those with the very best credentials, and those who run large firms. Consistent with the unique economic mechanism of market-based theories, CEO credentials have a positive impact on firm performance. The performance differential for newly-appointed CEOs is up to 0.5% per credential decile, and is also concentrated among CEOs with better reputational and career credentials and those at large firms. Credentials are positively correlated with unoberved CEO heterogeneity in pay and performance, which further validates our hypothesis that boards use them as publicly-observable signals of otherwise hard to gauge CEO skills. In all, our results offer direct evidence in support of market-based explanations of the overall rise in CEO pay.

The Stock Market Bubble, Shareholders' Attribution Bias and Excessive Top CEO Pay

I use aggregate time series data on profits in the corporate sector, Standard and Poor's Composite Stock Price Index, and the average total pay of the top 100 CEOs to look for evidence in favor or against a fundamental attribution bias-based explanation of the recent explosive growth in CEO pay. I hypothesize that shareholders overattribute prominent increases and decreases in the prices of corporate stocks to the leadership and skill of the CEOs and underplay the role of stock market fluctuations, which are beyond CEO control. I recast this hypothesis as a simple endogeneity test, and I cannot reject the view that market fluctuations mechanically cause changes in CEO compensation with no detectable reverse causality. Further I find that, in the aggregate data increases in CEO pay decrease corporate profits. To complement the time series evidence, I use 4-factor model risk-adjusted returns as a direct measure of CEO skill. I show that in the cross section the relationship between individual CEO pay and skill is very weak (economically small and statistically insignificant). I conclude that in the late1990s stock market bubble period shareholders were taken for a ride and ended up paying huge amounts of money to their CEOs for no rational reasons.

Urban Agglomeration and CEO Pay

This paper examines the impact of a firm's headquarters' location on its CEO compensation. Classifying Execucomp companies into rural, urban and small city firms, we find that rural firms exhibit significantly lower equity based pay-performance sensitivity levels and a more prevalent use of non-equity incentives than their urban and small city counterparts. A few factors drive our results. The first two factors are related to the greater difficulty of obtaining information and monitoring firms that are located further away from investors and monitoring agents, which make it more difficult to design effective market based incentives. The third factor is related to the demand for high quality human capital in urban firms. As competition increases, profits are more sensitive to cost reductions, and since high skilled workers are better at producing at lower costs, firms will be willing to pay them higher wages and steepen incentive schemes. Our evidence suggests that the relationship between CEO pay and firm performance is stronger in the presence of greater CEO skill, better information dissemination and strong external monitoring. Highly paid CEOs in these firms appear to be good CEOs; they earn more and produce better results. In such firms, problems of CEO compensation appear to be outliers rather than to reflect a systematic problem, consistent with the view of those who claim that there are only a few bad apples.

The Transferability of CEO Skills

Executives with concurrent multiple CEO appointments are the first focus of this study. The initial firms managed by this cohort group evidence superior profitability while the subsequent managed firms evidence, at a minimum, profitability competitive with other CEOs. For non-financial firms, transferable management skills and knowledge of the tasks associated with the multi-CEO position are sufficient for the generation of above average performance in subsequently managed firms. In the case of financial firms, subsequent performance matches typical firm performance. Direct evidence of transferable CEO skills is provided. Support for the benefits of firm knowledge and skills is also provided. In addition, ability and subsequent choice to become a multi-CEO is related to fewer firm governance constraints. This implies a conflict between the skills and corporate environment associated with better firm performance and increased levels of corporate governance. Finally, our focus broadens to all CEOs. In comparison to multi-CEOs and inside hires, externally hired CEOs underperform, especially if they were former CEOs after the 1980s.

The Impact of CEO Turnover on Firm Volatility

A change in executive leadership is a significant event in the life of a firm. This study investigates an important consequence of a CEO turnover: a change in equity volatility. We develop three hypotheses about how changes in CEO might affect stock-price volatility, and test these hypotheses using a sample of 872 CEO turnovers over the 1979 to 1995 period. We find that volatility increases following a CEO turnover, even for the most frequent type, when a CEO leaves voluntarily and is replaced by someone from inside the firm. Forced turnovers increase volatility more than voluntary turnovers, which we argue is consistent with forced departures implying a higher probability of large strategy changes. For voluntary departures, outside successions increase volatility more than inside successions, which we attribute to increased uncertainty over the successor CEO's skill in managing the firm's operations. We also document a greater stock-price response to earnings announcements following CEO turnover, consistent with more informative signals of value driving the increased volatility. Our findings are robust to controls for firm-specific characteristics such as changes in firm operations, firm size, and both volatility change and performance prior to the turnover.