CEO Compensation Structure Research Articles

EFFECT OF FAMILY OWNERSHIP AND MANAGEMENT ON CEO COMPENSATION AND DIVIDEND POLICY IN SMALL-CAP FIRMS

ABSTRACT This paper investigates CEO compensation structure and dividend policy of small publicly held family and nonfamily firms. We further study the differences between family firms with family CEOs and those with outsider CEOs. Unlike in other studies we do not find evidence of lower total compensation for CEOs at family firms when appropriate firm characteristics are accounted for. However, we do find that when the CEO is a family member, he/she receives lower salary and bonus compensation as compared to his/her counterpart. This cash compensation is further smaller for the family CEO when the company pays higher annual dividends. We find that family firms pay higher dividends and are more likely to increase or decrease dividends than other public firms but any such difference is confined to firms with non-family CEOs. Our results suggest that family CEOs rely on dividend income for a part of their stable income. Our results contradict Michaely and Roberts’ (2012) inference that dividends are not wage channels for owner-managers. Keywords family, ownership, compensation

Information Disclosure and CEO Compensation

Using the number of analysts and media coverage as the proxies for information amount and the dispersion of analysts’ forecasts and earnings volatility as the measurements for information quality, we show that the total levels of CEOs compensation increase with the increase in the amount of and the quality of information disclosure, and that there is an overall increase in CEO compensation after SOX. We further show that it is the equity-based compensation that drives our result. Firm has increased the equity-based CEO compensation, but not the non-equity-based CEO compensation in the post-SOX period. Our results suggest that information discourse has a significant impact on the structure and size of CEO compensation.

CEO Compensation and Fair Value Accounting: Evidence from Purchase Price Allocation

ABSTRACTThis study investigates the impact of CEO compensation structure on post‐acquisition purchase price allocation, an accounting procedure that involves fair value estimation of various assets and liabilities. We find that CEOs whose compensation packages rely more on earnings‐based bonuses are more likely to overallocate the purchase price to goodwill, the largest asset recorded post‐acquisition. Because goodwill is not amortized, the overallocation likely increases post‐acquisition earnings and bonuses. We also find that, when the acquirer's CEO bonus plan includes performance measures that are not affected, or are less affected, by the overstatement of goodwill, such as cash flows, sales, or earnings growth, the overallocation to goodwill motivated by bonus plans diminishes.

MOTIVATING CEOs TO FOCUS ON CUSTOMER SATISFACTION: IS LONG-TERM COMPENSATION THE ANSWER?

In recent years, the fi nancial value of customer relationships has received more attention from senior executives, who increasingly tend to see customer satisfaction as a valuable corporate intangible asset. Finding ways to encourage senior executives to build customer–fi rm relations and improve customer satisfaction, however, has been challenging. What incentives should fi rms employ to motivate CEOs to enhance customer satisfaction and thereby improve fi rm value? And what are the related mechanisms for doing so? A recent study by Xueming Luo (University of Texas at Arlington), Jan Wieseke (Ruhr-University Bochum), and Christian Homburg (University of Mannheim), helps answer those questions. Their study examines two routes of infl uence that fi rms can use when designing appropriate executive compensation structures aimed at raising fi rms’ customer satisfaction and market value. The fi rst route calls on external marketing to implement actions that build customer–fi rm relations. Luo and his colleagues conjecture that increasing the proportion of CEO long-term equity-based compensation will positively infl uence corporate engagement in long-term customer relationship management. Actions that build customer–fi rm relations should, in turn, improve customer satisfaction and ultimately raise fi rm value. Indeed, the “tone at the top”—often used to describe CEOs’ focus on fi nancial matters, such as quality fi nancial reporting and effective control systems—also applies to marketing efforts aimed at “knowing the customer,” including efforts to establish effective customer service departments that respond quickly to customer complaints. The second route of infl uence involves internal marketing, expecting that long-term equity-based CEO compensation will encourage actions to build employee–fi rm relations that positively affect customer satisfaction and fi rm value over time. Here the state of employee morale, internal communications (followed by actions that “walk the talk”), and performance-based salaries all contribute to employee attitudes toward the business and its customers. Both of these “marketing routes” use organizational actions to positively infl uence customer satisfaction—a key leverage point for raising sales, profi ts, and fi rm value. The external route specifi es direct fi rm efforts to improve customer satisfaction, while the internal route focuses on building those employee behaviors and attitudes that facilitate improved customer satisfaction. Furthermore, Luo and his colleagues proposed that the strength of the effects of CEO compensation structure on corporate actions to build customer and employee relations depends on market instability. Unstable markets often feature rapidly changing customer demands, short product cycles, and fi erce market competition (Dobni & Luffman, 2003). So in unstable markets, fi rms may have a greater need to motivate CEOs with compensation structures that build effective long-term customer–fi rm relationships as competition for customers becomes more intense and customers tend to be less bound to suppliers. Finally, Luo and his colleagues proposed that changes in corporate actions to build customer– and employee– fi rm relations positively infl uence changes in fi rmspecifi c customer satisfaction measures. Those changes in customer satisfaction partially explain the associations between changes in corporate actions to build customer—and employee—fi rm relations and changes in fi rm market value, making customer satisfaction a channel whereby CEO longterm equity compensation can affect fi rm market value.

Urban Agglomeration and CEO Compensation

An underlying assumption in the executive compensation literature is that there is a national labor market for CEOs. The urban economics literature, however, documents higher ability among workers in large metropolitians, which results in a real and stable urban wage premium. In this paper, we investigate the link between the spatial clustering of firms in big, central cities (i.e., urban agglomeration) and the level and structure of CEO compensation. Using CEO compensation data for the period 1992-2004, we document a positive relation between the size and centrality of the city in which the firm is headquartered and the total, as well as the equity based portion of CEO pay. Our results are robust to a host of control variables, sensitivity and endogeneity tests, indicating that urban agglomeration may reflect positive externalities, such as knowledge spillovers, business connections and improved access to private information that have a positive effect on CEO pay and incentive driven compensation for good performance. We document gradual human capital gains acquired from big city work experience that are transferable to the rural area, and rewarded for, once the CEO relocates into a smaller, less central community. Our tests provide novel evidence of information spillovers and networking opportunities in big cities that can directly affect how CEOs are compensated. Such sources of information and influence represent something for which firms are willing to pay higher and more incentive driven pay, evidence in favor of a market-based explanation for CEO compensation.

The timing of changes in CEO compensation from cash bonus to equity-based compensation: Determinants and performance consequences

This study examines the determinants and performance consequences of changes in CEO compensation structure. The study uses the unique setting when Australian companies have changed from cash bonus to equity-based compensation. While most US CEOs receive some form of equity-based compensation, Australian CEOs have not always been paid equity-based compensation. According to efficient contracting theories, we argue that the change to equity-based compensation is driven by changes in firm characteristics and by the occurrence of CEO turnover, the latter of which provides a less costly opportunity for such change. Our results are consistent with the above arguments. We also document a significant negative association between changes in compensation structure and subsequent firm performance in the following year, even after controlling for CEO turnover and poor governance environments. Overall, our results suggest that the initial change to equity-based compensation is part of an error learning process made by firms that leads them towards efficient CEO compensation contracts.

CEO Compensation and Board Structure – Rejoinder

In their reply to our critique, Chhaochharia and Grinstein (2012) suggest that (i) Apple is a prime example of how board regulations affect CEO pay and should therefore not be excluded from the study, and (ii) their original results are robust to excluding the outliers when extending the pre-event sample period from 2000 to 2002 back to 1996. In this rejoinder, we (i) dispute that Apple is a fitting example to illustrate the causal effect of board independence on CEO pay, (ii) caution against drawing conclusions about the robustness of the results from the new regression results in the reply (e.g., due to lack of relevance, sample selection issues, and more outlier effects), and (iii) argue that important omissions in the reply cast further doubt on the conclusions advocated by CG. In a nutshell, the existing evidence simply does not support the view that mandated board independence helps rein in executive compensation.

CEO Compensation and Board Structure Revisited – Addendum

Using Chhaochharia’s and Grinstein’s (JF, 2009) data and methodology, Guthrie, Sokolowsky, and Wan (JF, 2010) document that compensation committee independence leads to an increase in executive pay, and that the increase is concentrated in firms with powerful monitors. These findings stand in sharp contrast to the prediction of the managerial power hypothesis that director independence effectively curbs rent extraction in the form of excessive CEO pay. While it is tempting to reject the managerial power hypothesis, the evidence alternatively calls into question the effectiveness of director independence in corporate governance or the importance of reducing CEO pay to directors. In this addendum, we discuss these two possibilities.

CEO Compensation and Board Structure Revisited

ABSTRACTChhaochharia and Grinstein estimate that CEO pay decreases 17% more in firms that were not compliant with the recent NYSE/Nasdaq board independence requirement than in firms that were compliant. We document that 74% of this magnitude is attributable to two outliers of 865 sample firms. In addition, we find that the compensation committee independence requirement increases CEO total pay, particularly in the presence of effective shareholder monitoring. Our evidence casts doubt on the effectiveness of independent directors in constraining CEO pay as suggested by the managerial power hypothesis.

Effect of mandatory pro forma earnings disclosure on the relation between CEO share bonuses and firm performance

This paper examines the effect of mandatory pro forma earnings disclosure on the alignment of CEO share bonuses and firm performance (i.e., annual stock returns). Using 6,583 executive-level observations from 986 non-financial firms in Taiwan over the period 1999–2004, we find a significant shift in the CEO share bonus pay-earnings relation caused by a marked reduction in bonus shares after the new disclosure rule becomes effective. The change in CEO compensation structure in turn leads to a closer link between CEO stock bonuses and annual stock returns. The result suggests that a more transparent earnings disclosure could positively affect board choices regarding compensation arrangements, thus inducing a better convergence of manager and shareholder interests.

Urban Agglomeration and CEO Compensation

An underlying assumption in the executive compensation literature is that there is a national labor market for CEOs. The urban economics literature, however, documents higher ability among workers in large metropolitans, which results in a real and stable urban wage premium. In this paper, we investigate the link between the spatial clustering of firms in big, central cities (i.e., urban agglomeration) and the level and structure of CEO compensation. Using CEO compensation data for the period 1992-2004, we document a positive relation between the size and centrality of the city in which the firm is headquartered and the total, as well as the equity based portion of CEO pay. Our results are robust to a host of control variables, sensitivity and endogeneity tests, indicating that urban agglomeration may reflect positive externalities, such as knowledge spillovers, business connections and improved access to private information that have a positive effect on CEO pay and incentive driven compensation for good performance. We document gradual human capital gains acquired from big city work experience that are transferable to the rural area, and rewarded for, once the CEO relocates into a smaller, less central community. Our tests provide novel evidence of information spillovers and networking opportunities in big cities that can directly affect how CEOs are compensated. Such sources of information and influence represent something for which firms are willing to pay higher and more incentive driven pay, evidence in favor of a market-based explanation for CEO compensation. Key words: Agglomeration, CEO, Compensation, Incentive, Geography. JEL Code: D8, G3, J3, R1

Do CEO compensation incentives affect firm innovation?

PurposeThe purpose of this paper is to examine if the structure and design of CEO compensation has any effect on firm innovation. It further investigates the effectiveness of each component of portfolio of compensation incentives in encouraging innovation.Design/methodology/approachThis study uses systems of simultaneous equations to model the interdependence between compensation incentives and measures of firm innovation.FindingsResults indicate that the pay‐performance sensitivity of the CEO portfolio of compensation incentives is positively related to investment in R&D expenditures, number of patents and citations. Options in general are more effective than stocks. However, within the options portfolio, recently awarded and unvested options are more effective than previously awarded and vested options. Restricted stock is more effective than unrestricted stock.Research limitations/implicationsMeasuring innovation output is difficult as innovation could take different forms, including business model innovation, which does not appear in the patent data.Practical implicationsStock options encourage investment in value‐increasing innovations and should remain a significant part of managerial compensation. If the firm awards stock, it should only award restricted stock.Originality/valueThis study uses comprehensive measures of compensation incentives and firm innovation. It views incentives as a portfolio of stock and options and uses incentives in their entirety. It examines the effectiveness of each component of the portfolio in encouraging innovation. It measures innovation as investment into the innovation process (R&D expenditures) and the resulting success of that investment (patents and citations).

Impact of CEO Compensation Structure on Cost Stickiness

Impact of CEO Compensation Structure on Cost Stickiness

Institutional Investment Horizons and CEO Compensation

I investigate the relation between the structure of CEO compensation and the investment horizons of a firm’s institutional investors and find results consistent with the assertion that short-sighted institutions’ focus on shortterm earnings leads firms to grant more options with higher sensitivity to stock price. In contrast, the percentage holdings of long-term investors are negatively correlated with the use of options and the sensitivity of total CEO equity incentives to changes in stock price. Further results suggest that firms with higher short-term institutional ownership are more concerned about a negative earnings surprise and that when determining annual bonuses, they punish their CEOs more severely. In total, the analyses provide evidence that the investment horizon of institutional investors is associated with firms’ CEO compensation policies. * I thank Christine Botosan, Mary Ellen Carter, John Core, William Cready, Fabrizio Ferri, Rachel Hayes, Lee-Seok Hwang, Li Jin, Ella Mae Matsumura, Martin Wu, and workshop participants at the University of Illinois at UrbanaChampaign, at the University of Utah, at the University of Wisconsin-Madison, at Korea University, at Seoul National University, and at the Korea Advanced Institute of Science and Technology (KAIST) for many helpful comments. Many helpful comments were also received from conference participants at the 4 Asian Corporate Governance Conference in Seoul, South Korea, at the American Accounting Association Annual Meeting, at the Mid-year Meeting of the American Accounting Association’s Management-Accounting Section, and at the 16 Annual Conference on Financial Economics and Accounting (FEA) at the University of North Carolina at Chapel Hill. I gratefully acknowledge financial support from the Institute of Management Research at Seoul National University. This work was also supported by Research Settlement Fund for the new faculty of SNU. ** Assistant Professor, College of Business Administration, Seoul National University, 599 Gwanangno, Gwanak-gu, Seoul, Korea, 151-916 (jshin@snu.ac.kr), Phone: +85-2-880-6940 94 Seoul Journal of Business

The Agency Problem, Corporate Governance, and the Asymmetrical Behavior of Selling, General, and Administrative Costs

Prior studies have documented the asymmetrical behavior of selling, general and administrative (SG&A) costs (i.e., SG&A costs increase more when activity rises than they decrease when activity falls), and have explained this phenomenon primarily with economic factors. Drawing on agency theory, we argue that SG&A cost asymmetry is driven not only by economic factors but also by the agency problem which causes a shift in SG&A cost asymmetry away from its optimal level. Using data for S&P 1500 firms over the period 1996–2005, we find that the degree of SG&A cost asymmetry is positively associated with managers’ empire building incentives due to the agency problem (measured by free cash flow and CEO horizon, tenure, and compensation structure), suggesting that the agency problem provides an additional explanation for SG&A cost asymmetry. Moreover, we find that strong corporate governance mitigates the positive association between the agency problem and the degree of SG&A cost asymmetry. In additional analyses, we also find that the agency problem influences cost stickiness to a greater extent in mature firms and in firms where SG&A costs create low future value.

Investment Opportunity Set, Product Mix, and the Relationship between Bank CEO Compensation and Risk-Taking

The product mix changes that have occurred in banking organizations during the 1990s provide a natural experiment for investigating how firms adjust their executive compensation contracts as their mix of businesses changes. Deregulation and new technology have eroded banking organizations’ comparative advantages and have made it easier for nonbank competitors to enter banking organizations’ lending and deposit-taking businesses. In response, banking organizations have shifted their sale mix toward noninterest income by engaging in municipal revenue bond underwriting, commercial paper underwriting, discount brokering, managing and advising open- and close-ended mutual funds, underwriting mortgage-backed securities, selling and underwriting various forms of insurance products, selling annuities, and other investment banking activities via Section 20 subsidiaries. These mix changes could affect firms’ risk and the structure of CEO compensation. The authors find that as the average banking organization tilts its product mix toward fee-based activities and away from traditional activities, equity-based compensation increases. They also find that more risky banks have significantly higher levels of equity-based compensation, as do banks with more investment opportunities. But, more levered banks do not have higher levels of equity-based CEO compensation. Finally, the authors observe that equity-based compensation is more important after the Riegle-Neal Act of 1994.

CEO incentives and bank risk

We investigate the relationship between CEO compensation and bank default risk predictors to determine if short-term incentives can explain recent excesses in bank risk. We investigate early warning off-site surveillance parameters and expected default frequency (EDF) as well as crisis-related risky bank activities. We find only modest evidence that CEO compensation structures promote significant firm-specific heterogeneity in bank risk measures or risky activities. Compensation elements commonly thought to be the riskiest components, unvested options and bonuses, are either insignificant or negatively correlated with common risk variables, and only positively significant in predicting the level of trading assets and securitization income.

CEO Compensation and Board Structure Revisited

Chhaochharia and Grinstein (JF, 2009) estimate that CEO pay decreases by 17% more in firms that were not compliant with the recent NYSE/NASDAQ board independence requirement than in firms that were compliant. We document that 74% of this magnitude is attributable to two outliers out of 865 sample firms. In addition, we find that the compensation committee independence requirement increases CEO total pay, particularly in the presence of effective shareholder monitoring. Our evidence casts doubt on the effectiveness of independent directors in constraining CEO pay as suggested by the managerial power hypothesis.

The effect of CEO tenure on CEO compensation

PurposeThe paper aims to study the effect of tenure on the structure of CEO compensation. The relation between CEO compensation and CEO tenure provides a good testing bed for many effects: the managerial power effect, the portfolio consideration effect, the learning effect, and the career concern effect.Design/methodology/approachTobit regressions were run of the percentage of equity‐based compensation on CEO tenure and the effect of tenure compared between inside CEOs and outside CEOs.FindingsIt was found that the percentage of equity‐based compensation increases during the early years of tenure for outside CEOs, and decreases during the later years of tenure for inside CEOs. Before they are tenured, outside CEOs have significantly higher and faster growing percentage of equity‐based compensation than inside CEOs. Furthermore, the portfolio consideration effect and the learning effect are the major effects in explaining the effect of tenure on the compensation structure.Practical implicationsThe evidence that boards of directors take into account the CEOs’ holdings of equity incentives, the types of CEOs, and their years on tenure to adjust the structure of CEO compensation indicates that firms should, and do, try to optimize their CEO compensation structure on the basis of firm‐specific or CEO‐specific characteristics. It is suggested that there is no simple formulaic approach to governance reform.Originality/valueThe paper contributes to the literature by studying and explaining the different patterns of compensation structure over CEO tenure between inside CEOs and outside CEOs.

CEO compensation structure and firm performance

AbstractThe objectives of our study are to estimate a model of ‘efficient’ compensation structure based on firm characteristics and test the performance consequences of deviation from the efficient compensation structure. Our results are based on 3503 firm years for the period from 1999 to 2005. The results suggest that firms whose CEOs receive compensation inconsistent with their firm characteristics have a lower performance compared to those firms whose CEOs’ compensation is consistent with their firms’ characteristics. Our measure of performance is based on both accounting and market‐based performance measures. Overall, our study provides some important new insights into the links between CEO compensation structure and firm performance.