CEO Talent Research Articles

Air quality and CEO cross–regional turnover ——The role of compensation or incentive

We investigate firms' strategies to cope with the brain drain effect induced by air pollution. We presume that firms located in more polluted areas need to compensate for unpleasant locations in order to attract new CEO talent. Empirically, we find that firms located in more polluted areas are more likely to provide higher compensation packages or promotion incentives for successor CEOs from less polluted areas. The results are robust to using regional thermal inversion as an instrument, a regression discontinuity design, using alternative measures for air pollution, and ruling out alternative explanations. Additionally, the results are more pronounced when CEOs come from relatively less polluted overseas regions and for firms that have more industry peers outside this province, and are located in a region with poorer geographic livability. Overall, this paper provides the complete picture of the relation between air pollution and CEO turnover.

Labor Market Benefit of Disaggregated Disclosure*

ABSTRACTAsymmetric information is a fundamental friction that results in mismatches and efficiency losses in the labor market. In this study, we posit that more disaggregated financial disclosure by a CEO candidate's prior employer can help the hiring firm better assess the possible fit between its operational needs and the candidate's skill set. Using a mandatory segment reporting reform in the United States (SFAS 131) as an exogenous shock to disclosure disaggregation, we find a significant increase in the firm‐CEO match quality when the hiring firm has access to more disaggregated segment information about the external candidate's past employment. Furthermore, the improvement in firm‐CEO matching is greater when segment information is incrementally more useful for evaluation of candidate skills. These findings reveal a novel labor market benefit of disaggregated financial disclosure: alleviating pre‐hiring information deficiencies and facilitating efficient allocation of CEO talent across firms.

Aggressive Boards and CEO Turnover

ABSTRACTThis study investigates a communication game between a CEO and a board of directors where the CEO's career concerns can potentially impede value‐increasing informative communication. By adopting a policy of aggressive boards (excessive replacement), shareholders can facilitate communication between the CEO and the board. The results are in contrast to the multitude of models which generally find that management‐friendly boards improve communication, and help to explain empirical results concerning CEO turnover. The results also provide the following novel predictions concerning variation in CEO turnover: (1) there is greater CEO turnover in firms or industries where CEO performance is relatively more difficult to assess; (2) the board is more aggressive in their replacement of the CEO in industries or firms where the board's advisory role is more salient; and (3) there is comparatively less CEO turnover in firms or industries where the variance of CEO talent is high.

Aggressive Boards and CEO Turnover

This study investigates a communication game between a CEO and a board of directors where the CEO's career concerns can potentially impede value-increasing informative communication. By adopting a policy of aggressive boards (excessive replacement), shareholders can facilitate communication between the CEO and the board. The results are in contrast to the multitude of models which generally find that management-friendly boards improve communication, and help to explain empirical results concerning CEO turnover. The results also provide the following novel predictions concerning variation in CEO turnover: (i) there is greater CEO turnover in firms or industries where CEO performance is relatively more difficult to assess; (ii) the board is more aggressive in their replacement of the CEO in industries or firms where the board's advisory role is more salient; and (iii) there is comparatively less CEO turnover in firms or industries where the variance of CEO talent is high.

Does the use of non‐GAAP earnings in compensation contracts lead to excessive CEO compensation? Efficient contracting versus managerial power

AbstractWe examine whether the recent trend of firms’ using non‐GAAP earnings metrics in compensation contracts is consistent with the efficient contracting hypothesis or the managerial power hypothesis. We extract non‐GAAP performance metrics from compensation contracts in proxy statements of S&P 500 firms from 2006 to 2013. We find that the adoption of non‐GAAP earnings in CEOs’ compensation contracts is positively associated with CEOs’ cash compensation. However, the increase in CEOs’ compensation is primarily evident among firms with superior CEO talent. In addition, we find that the cash pay‐performance sensitivity (PPS) increases after the adoption of non‐GAAP performance measures, suggesting that boards use non‐GAAP performance measures to enhance CEOs’ performance‐improving incentives, rather than granting excessive compensation. Overall, our evidence suggests that, on average, the use of non‐GAAP performance metrics in executive compensation contracts reflects boards’ efforts to retain talented CEOs and mitigate agency problems, which is consistent with the efficient contracting hypothesis.

Labor Market Benefit of Disaggregated Disclosure

Asymmetric information is a fundamental friction that results in mismatches and efficiency losses in the labor market. In this paper, we posit that more disaggregated financial disclosure from a CEO candidate’s prior employer can help the hiring firm better assess the possible fit between its operational needs and the candidate’s skill set. Using a mandatory segment reporting reform in the U.S. (SFAS 131) as an exogenous shock to disclosure disaggregation, we find a significant increase in the firm-CEO match quality when the hiring firm has access to more disaggregated segment information about the external candidate’s past employment. Further, the improvement in firm-CEO matching is greater when segment information is incrementally more useful for evaluation of candidate skills. These findings reveal a novel labor market benefit of disaggregated disclosure: alleviating pre-hiring information deficiencies and facilitating efficient allocation of CEO talent across firms.

Variation in Executive Compensation and Allocation of Cash Flow

This study investigates whether the variation in executive compensation play an important role in allocation of internal generated cash flow. Several financial literature focus on the issue of cash-flow sensitivity on various uses of internally generated cash flow. Firms are able to distribute their incremental cash flow to payout dividends, reimburse debt, raise equity, hold cash as precautionary savings or increase the investment to obtain the growth opportunity in the future. However, a few studies investigate the change in cash-flow sensitivity on various uses after incorporating the variation in executive compensations and other control variables. According to academic theory of incentive-pay and agency problems, CEOs have incentive to allocate more cash flow to risky investment projects in order to increase their contingent rewards if there is more free cash flow in a firm. Accordingly, we propose that cash-flow sensitivity on investment and cash holding are more volatile than other uses in firms when we take account of variation in different types of executive compensation. This proposition highlight an interesting phenomenon that overinvestment directly connects to overpayment of CEOs. Moreover, we clarify that restriction on executive compensation, perhaps reduces the agency cost but it also forces firms to reduce managerial talent or effort such that cash-flow sensitivity of various uses would rely on the type of executive compensation. Using the cash-flow sensitivity model, we find that the variation in executive compensation would change the allocation of cash flow and lead to agency problems. After controlling the firm’s characteristics, CEO’s characteristics and governance characteristics, we highlight that time varying excess executive compensation significantly explain the cash-flow sensitivity on various uses. In particular, the performance-sensitive pay (incentive-pay) induced by self-serving motivation and unobserved CEO talent is responsible for variation in cash-flow sensitivity on internal cash flow allocation.

CEO pay ratios and financial reporting quality

We address the Dodd Frank Act controversy about the usefulness of the CEO pay ratio to investors by investigating the relationship between that ratio and financial quality, measured by the level of discretionary accruals and the likelihood of restating previously issued financial statements. We test two conflicting explanations of pay disparity: (1) competition for CEO talent and (2) managerial rent-seeking. Though we find that the unconditional relationship between the CEO pay ratio and financial quality is negative, the sign of this relationship is sensitive to CEO power and competence. Our findings suggest that the pay ratio does shed light on the fairness of compensation structures.

Peer Group Choice and Chief Executive Officer Compensation

We examine the selection of peer groups that boards of directors use when setting CEO compensation. The challenge is to ascertain whether peer groups are selected to (i) attract and retain executive talent and/or (ii) enable rent extraction by inappropriately increasing compensation. We find that the inferences in prior research are based on questionable methodological choices and do not generalize with an expanded sample. After addressing these concerns, we find that, on average, excess peer compensation has a negative association with future firm operating performance. However, significant variation in CEO talent and corporate governance exists within the cross-section of firms. The negative association between excess peer compensation and future performance is mitigated when the firm has a high level of CEO talent, and exacerbated when the firm has low-quality corporate governance. Thus, the economic consequences of peer-group choice are highly contextual. In general, we find that talent motivations explain more of the variation in the future performance implications of peer-group choice than corporate governance.

Selection Versus Incentives in Incentive Pay: Evidence from a Matching Model

Higher incentive pay is associated with higher firm value. I introduce a model of CEO-firm matching to disentangle the two confounding effects that drive this result. First, higher incentive pay directly induces more effort; second, talented CEOs sort into firms pay higher incentive pay. I find that both effects contribute to the result, with the selection effect accounting for almost one-quarter of the total effect. The relative importance of the selection effect is the largest in submarkets with high talent mobility and in more recent years.

CEO talent: A dime a dozen, or worth its weight in gold?

AbstractVery little sophisticated research exists on the size, quality, and efficiency of the labor market for CEO talent. This paper sheds light on this labor market by considering the perspectives of directors directly responsible for hiring and firing the CEOs of the largest publicly traded corporations in the United States. We find that directors overwhelmingly believe that the CEO job is exceptionally challenging and only a handful of executives are qualified to run their company and others in their industry. This suggests that the labor market for outstanding CEO talent is significantly tighter and more competitive than governance experts might realize.

Market for CEO talent, determinants and consequences

This paper investigates the rare situations in which the CEO of one firm (old) is hired by another firm (new). We find that a majority of the new firms have recently experienced an involuntary turnover, and most of the old firms replace a departing CEO with an insider. The market reacts negatively to the departure of these CEOs and positively to their hiring by new firms. Our findings suggest that bigger but less profitable firms are able to hire other firms' CEOs. These CEOs receive increased compensation and media visibility after the turnover. The old firms' operating performance decreases significantly after these CEOs leave, while the operating performance of the new firms changes insignificantly.

High CEO Pay Ratios: Governance Failure or Superior Performance?

The ratio of CEO to average worker compensation (CEO pay ratio) in the U.S. has risen rapidly in recent years. There is an intense debate over whether high CEO pay ratios reflect managerial rent extraction and corporate governance failures, or firms’ ability to secure superior CEO talent, which is in short supply. To shed light on this debate, this study examines the relationship between CEO pay ratio and firm value/performance. We find that industry-adjusted CEO pay ratios are positively associated with both firm value and performance. In addition, firms with high CEO pay ratios are more likely to engage in value-enhancing acquisitions and exhibit stronger CEO turnover-performance sensitivity. Together, our results suggest that on average, high CEO pay ratios indicate firms’ success in securing scarce CEO talent, not a failure in corporate governance.

The Externality in the CEO Market and Regulating Board Independence

This paper discusses shareholder value and regulation on board independence. Shareholder value increases with a firm’s and, more importantly, other firms’ board independence. Shareholders set inefficiently low board independence because they fail to internalize the positive externality of higher board independence on other firms or they use low board independence to compete for CEO talent. This suggests that shareholder activism cannot substitute regulation. However, mandating minimum board independence can only remove the inefficiency caused by talent competition but not externality.

Banking Non Performing Loans and Banking CEO Talent

In the literature there are a lot of factors considered as banking non-performing loans (NPL) determinants. However, one factor is missing: banking CEO talent. In the present paper an effort will be made to estimate the impact of banking CEO talent on banking NPLs. To this end Eviews software will be used. The sample examined covers annually (2000-2007) the countries: Austria, Belgium, Denmark, Finland, Germany (2001-2007), Ireland, Italy, Netherlands, Norway, Spain, Sweden and USA (2001-2007).

Peer group benchmarking in CEO compensation and firm innovation: evidence from patents and citations

This study provides empirical evidence on the relation between peer group benchmarking in CEO compensation and firm innovation measured by number of patents and citations. Results show that peer group benchmarking and firm innovation are positively related. However, this positive relation holds only for CEOs who receive higher than median peer group compensation. For CEOs who receive lower than median peer group compensation, benchmarking seems to have no statistically significant effect on firm innovation. The study also finds that CEO compensation benchmarked against median peer group compensation is positively related to one-year and five-year stock return volatility. Overall, results suggest that benchmarking in CEO compensation is an efficient response to competitive pressures in CEO talent market and is not driven by an intentional effort by the powerful CEOs to extract rents from their firms.

Succession 'Losers': What Happens to Executives Passed Over for the CEO Job?

Shareholders pay considerable attention to the choice of executive selected as the new CEO whenever a change in leadership takes place. However, without an inside look at the leading candidates to assume the CEO role, it is difficult for shareholders to tell whether the board has made the correct choice. In this Closer Look, we examine CEO succession events among the largest 100 companies over a ten-year period to determine what happens to the executives who were not selected (i.e., the “succession losers”) and how they perform relative to those who were selected (the “succession winners”).We ask: Are the executives selected for the CEO role really better than those passed over? What are the implications for understanding the labor market for executive talent? Are differences in performance due to operating conditions or quality of available talent? Are boards better at identifying CEO talent than other research generally suggests?The Stanford Closer Look series is a collection of short case studies through which we explore topics, issues, and controversies in corporate governance and executive leadership. In each study, we take a targeted look at a specific issue that is relevant to the current debate on governance and explain why it is so important. Larcker and Tayan are co-authors of the books “Corporate Governance Matters” and “A Real Look at Real World Corporate Governance.”

CEO Talent, CEO Compensation and Product Market Competition

We develop a structural industry equilibrium model to show how competitive CEO-firm matching and product markets jointly determine firm value and CEO pay. We analytically derive testable implications for the effects of product market characteristics on firm size, CEO pay, and CEO impact on firm value. CEO talent matters more in more competitive markets with greater product substitutabilities. Our CEO impact estimates are much higher than those obtained by previous structural approaches that abstract away from CEO market segmentation. The estimates differ across industries primarily due to variation in product market competition, rather than variation in the CEO talent distribution.

The Effects of CEO Pay Transparency in France: Benchmarking, 'Catching-Up', and Outsider Scrutiny

The study investigates the evolution of CEO pay after the implementation of new disclosure rules in France. It opposes a managerial labor market view in which firms compete for CEO talent, and a governance institutions view that embraces managerial power, outrage constraint, and agency issues. The findings first show that closely-monitored and below-average CEOs make the most of benchmarking to catch up to their peers. The catch-up effect is partly driven by competition for talent but also by imitation and perceived fairness. Second, public disclosure places CEO pay under outsider scrutiny, producing two distinct effects: most powerful and above-average CEOs receive lower pay rises, and minority shareholders pressure firms into rising bonuses for all CEOs. Overall, transparency yields a convergence of pay levels and higher ratios of bonuses.

Career Concerns and Product Market Competition

This paper studies the effect of increased competition in the product market on managerial incentives. I propose a simple model of career concerns where firms are willing to pay for managerial talent to reduce production costs, but also to subtract talented CEOs from competitors. This second effect is privately valuable to firms, but is socially wasteful. As a result, equilibrium pay for talent can be inefficiently high and career concerns too strong. Explicit incentive contracts do not solve the problem, but equilibrium pay is reduced if managerial skills have firm-specific components, or if firms are heterogeneous. In this second case, managers are efficiently assigned to firms, but equilibrium pay reflects the profitability of talent outside the efficient allocation. The effect of increased competition is ambiguous in general, and depends on the profit sensitivity to cost reductions. This ambiguity is illustrated in two examples of commonly used models of imperfect competition.