CEO Incentives Research Articles

The impact of unions on compensation consultants and CEO pay

AbstractResearch on executive compensation finds unions to be associated with lower executive compensation, particularly incentive pay, while other work documents the role of compensation consultants in facilitating stronger CEO incentives and pay. We propose and test the implications of a simple theoretical framework that integrates these empirical findings. We find empirical support for our model's prediction that in environments less favorable to union organization (e.g., right‐to‐work states), firms with higher unionization rates strategically engage consultants to counter union influence, place greater value on their advice as gauged by consultant fees, and offer managers greater equity incentives opposed by unions. On the other hand, in strongly prolabor environments, unions are more successful at curtailing consultant use and have greater influence on the level of pay and incentives.

Venture capitalist directors and managerial incentives

We examine the effect of board members with venture capital experience (VC directors) on executive incentives at non-venture-backed public firms. VC directors serving on the compensation committee are associated with greater CEO risk-taking incentives (vega) and pay-for-performance sensitivity (delta). These effects are more substantial if VC directors are from highly reputable VC firms. Using the change of direct flight availability to VC hub cities caused by major airline mergers and annual estimates of VC dry powder per industry as instruments, we show that these results are causal. In addition, VC directors are more focused on growth performance goals in CEO compensation contracts. We also document that prior finding of greater research intensity and innovation when VC directors serve on boards of public firms is partly explained by stronger CEO incentives instilled by such directors. Lastly, we find that having VC directors on nominating and/or governance committees is associated with a higher likelihood of forced CEO turnover.

How Large Is the Pay Premium from Executive Incentive Compensation?

ABSTRACT We estimate the pay premium associated with CEO incentive compensation. Using explicit detailed U.S. CEO compensation contract data and simulation analysis, we find that CEOs with riskier pay packages receive a premium for pay at risk that represents 13.5 percent of total pay. The premium is positively correlated with proxies for CEO risk aversion, but implied risk aversion values suggest that the premium is economically smaller than suggested by prior studies. We perform our tests using a variety of proxies to measure the variance of pay and find consistent evidence of economically small pay risk premiums. These results are consistent with recent findings suggesting that risk may have a more limited influence over the level of pay than previously thought. Data Availability: Data are available from the public sources cited in the text. JEL Classifications: D81; G30; J33.

CEO Restricted Stock, Incentives, and Corporate Innovations*

AbstractWe study the relation between CEO restricted stock, CEO incentives, and firm innovation. We first show that restricted stock is negatively associated with R&D investment. We also show that CEO restricted stock is positively related to the number of patents granted and citations received. However, further investigation shows that CEO restricted stock has a positive relation with firm exploitation but a negative relation with firm exploration and breakthrough innovation. The results suggest that restricted stock appears to incentivize CEOs to make efficient R&D investments and produce more innovative outputs in general, but only through exploitation rather than exploration and breakthrough innovations.

Foundation-controlled firms and CEO compensation

We explore the effects of foundation control on CEO incentive contracts. Unlike other blockholders, foundations do not consume the entirety of their cash flow rights, which attenuates the incentives of the controlling foundations to directly monitor the management. We present a simple model of moral hazard which predicts that foundation-controlled (FC) firms will resort to executive compensation as an alternative disciplining mechanism. Using a sample of listed Swedish family firms over the period of 2001–2014, we find that CEOs in FC firms are awarded more stock options compared to their peers in non-FC firms. The performance sensitivity of their option portfolios is also higher, but we do not find this to be the case for stock grants. Lastly, there is no conclusive evidence of differences in the levels of cash compensation. Our findings support the view that incentive contracts can substitute for large shareholder monitoring.

CEO incentive pay and corporate social performance: Evidence from French companies

Drawing on stakeholder and legitimacy theories, this study investigates the influence of CEO incentive pay on corporate social performance (CSP) and the moderating effect of the economic crisis on this relationship within the French context. Using a sample of 460 firm-year observations of listed French firms, we provide new empirical evidence of a positive relationship between CEO incentive pay and CSP, as well as each of the process dimensions governing this construct (Leadership, Implementation, and Results). However, this relationship is altered by the economic crisis, which affects only one dimension of CSP (Leadership). These findings indicate that due to economic concerns, CEOs may shift efforts toward communicating rather than implementing CSP; however, they also might reflect defensive strategies intended to reassure stakeholders in a strained global economic context marked by declining of the financial performance.On a managerial level, this study provides evidence for executives, analysts, and policymakers that CEO incentive pay can serve as a potent strategic lever to enhance CSP. Nevertheless, our findings urge various stakeholders involved in corporate social responsibility (CSR) to strengthen their control over the effectiveness of the firm's social performance rather than merely accepting the firm's declarations that might be amplified in times of crises without a real commitment to CSP activities.

CEO Incentives for Risk-Taking and Compensation Duration

CEO Incentives for Risk-Taking and Compensation Duration

Short selling and firm investment efficiency

This paper investigates the informativeness of short sales on detecting firm investment inefficiency. Neoclassical and agency theory suggest that investment inefficiency destroys firm value by allocating resources to less-valued uses. This paper finds that short-sellers adjust their short positions before the announcement of a financial statement, to use their information advantage on firm investment inefficiency. The relation between the short positions in a firm and its future investment inefficiency is both statistically and economically significant, and robust to a broad set of control variables. Subsample analyses show that the informativeness of short sales positions about future investment inefficiency is concentrated on overinvestment firms, firms with little board independence, and firms with low CEO incentive pay.

Disturbing the Quiet Life? Competition and CEO Incentives

ABSTRACT Although it is well understood that product market competition acts as a disciplining mechanism that reduces inefficiencies, our understanding of the implications for firms’ incentive design choices is still limited. We use a comprehensive new measure of competition and examine its effect on four major choices: CEO equity portfolio incentives, annual bonus plan incentives, choice of performance measures, and difficulty of financial performance targets. We find that competition reduces firm profits and total CEO compensation, including equity grants, which then also weakens portfolio incentives. Firms respond by adjusting annual bonus plans to restore incentives. Specifically, we find that competition goes together with stronger bonus plan incentives, more challenging annual performance targets, and a greater emphasis on long-term performance measures. Finally, we show that competition increases performance relative to annual bonus targets, which we interpret as evidence that CEOs work harder but get paid less in highly competitive environments. Data Availability: Data are available from the public sources cited in the text. JEL Classifications: M41; M52.

Earnings per share targets and CEO incentives

Earnings per share targets and CEO incentives

Estimating the sensitivity of CEO compensation to gross versus net accounting performance

AbstractIn empirically estimating the relation between CEO compensation and accounting‐based firm and peer performance, researchers often define the performance variables net of CEO compensation expense. We analytically show that a researcher's use of CEO compensation as a regression's dependent variable and as an expense in defining a regression's independent variables representing accounting‐based firm and peer performance will bias the researcher's pay‐for‐performance and relative performance evaluation (RPE) regression coefficients. In a panel estimation of CEO compensation, we document an attenuation bias in the coefficients on net firm and net peer performance. This evidence may partially explain inferences of weak CEO incentives and limited usage of RPE in prior work. Our results imply that in CEO compensation regressions, a researcher can remove biases in inferring CEO incentives and RPE usage by using gross rather than net accounting performance variables—that is, by adding back CEO compensation expense to net accounting measures.

Tax Tightrope: The Perils of Foreign Ownership, Executive Incentives and Transfer Pricing in Indonesian Banking

Despite being a crucial source of funding for the government, tax revenue collection in Indonesia has yet to reach its ideal and satisfying level for the economy. Therefore, this study explores the impact of executive incentives, foreign ownership, and transfer pricing on tax avoidance. The conventional banks of Indonesia that were listed on the Indonesia Stock Exchange (IDX) between 2015 and 2019 are the subject of this study. This study employed a purposive selection technique, with a final sample of 17 banks chosen after screening to ensure they met the requirements of having foreign ownership and not having suffered losses during the study year. The results of this study show that while CEO incentives harm tax avoidance, foreign ownership has a beneficial effect. Furthermore, tax avoidance is not significantly impacted by transfer pricing. The findings of this investigation open the door for accountable authorities in the economy.

Female Directors, Earnings Management, and CEO Incentive Compensation: UK Evidence

Female Directors, Earnings Management, and CEO Incentive Compensation: UK Evidence

CEOs’ capital gains tax liabilities and accounting conservatism

AbstractRecent studies show that the tax‐induced lock‐in effect discourages CEOs from unwinding their unrestricted equity and subsequently exacerbates their risk‐aversion. I investigate how CEOs’ unrealized capital gains tax liabilities (tax burdens) influence financial reporting conservatism. I find that the demand for accounting conservatism decreases with CEO tax burdens. Further analyses show that the negative relation between CEO tax burden and conservatism is stronger when the firm has high leverage and high default risk and when the CEO's incentives are more aligned with equity holders. This highlights the shareholder–creditor agency conflicts mitigation role of CEO tax burdens in reducing creditors’ demand for conservatism. I exploit the Federal Taxpayer Reform Act of 1997 and staggered state‐level tax cuts that significantly decreased personal capital gains tax rates as identification strategies.

Does CEO Power Affect the Relations between CEO Compensation and Risk-Taking?

Purpose - This study investigates the effect of incentive compensation and CEO power on a firm’s risk-taking behavior, leveraging stock return volatility and earnings volatility as the key indicators of risk-taking.
 Design/Methodology/Approach - A comprehensive analysis is conducted using data from 1,958 U.S. firms over a 28-year period (1992- 2019). The study employ both ordinary least square (OLS) regression and two-stage least square (2SLS) regression for analysis. Pay-volatility sensitivity (PVS) and CEO-pay slice (CPS) are used as proxies for incentive compensation and CEO power, respectively.
 Findings - The findings offer solid empirical proof that PVS and CPS have a negative influence on both earnings volatility and stock return volatility. Furthermore, the detrimental effect of PVS on managerial risk-taking is significantly more pronounced for CEOs with lower CPS compared with those with higher CPS. While incentive compensation appears to deter CEOs from embracing higher risks, CEOs with more power are less risk-averse when offered incentive compensation compared to their less powerful counterparts.
 Research Implications - This study significantly contributes to existing literature by revealing the interactive effects between CEO power and incentive compensation on a firm’s risk-taking behavior. Understanding these dynamics is pivotal as it offers a nuanced view of how CEO compensation structures and power hierarchies within a firm influence its risk-taking propensity, which is critical for both firm performance and broader financial stability considerations. The insights derived from this analysis can inform more balanced executive compensation structures and governance models that ensure an optimal level of risk-taking.

CEO power, corporate risk management, and dividends: disentangling CEO managerial ability from entrenchment

We contribute to the literature on dividend policy by considering two largely ignored, yet important factors, namely CEO power and corporate risk management. We first disentangle CEO managerial ability from entrenchment - the two sources of leadership autonomy that are not normally distinguished in prior literature. Using UK (re)insurance data that allows us to objectively and reliably quantify risk management and to identify powerful stakeholders with monitoring incentives (e.g., shareholders and regulatory body), we find that risk management enables entrenched CEOs to increase dividends to avoid monitoring by shareholders without compromising financial resilience and increasing the risk of regulatory scrutiny. Further, we neither find the degree of CEO managerial ability nor its interaction with risk management to be related to dividends, suggesting that the competing incentives for talented CEOs to pay higher/lower level of dividends cancel out in cross-sectional tests. Nonetheless, we find that the signalling effects of dividends for future accounting earnings only exist in insurers with high ability CEOs. This is consistent with the view that talented CEOs are able to generate sustainable earnings, and when they choose to pay (more) dividends, they do so to externally signal their managerial ability.

Do CEO risk-reducing incentives affect operating leverage? Evidence from CEO inside debt holdings

Purpose The purpose of this paper is to investigate the relationship between CEOs' inside debt holdings (pension benefits and deferred compensation) and the operating leverage of the firms they manage, with the aim to examine whether CEO incentives play a role in corporate risk-taking. Design/methodology/approach The authors investigate the relation between CEO inside debt holdings (CIDH) (pension benefits and deferred compensation) and the operating leverage (DOL) of the firms they manage. Using a sample of 11,145 US firm-year observations over the period 2006–2017, the authors find a strong negative association between CIDH and DOL. Additional analyses reveal that the relationship between CIDH and DOL is more pronounced in firms with heightened agency issues, powerful CEOs and for CEOs with stronger professional networks. The results are robust to various sensitivity and endogeneity tests. Findings The authors find strong evidence confirming the expected negative association between CEO inside debt and DOL suggesting that firms with higher inside debt tend to maintain lower levels of operating leverage. These findings continue to hold with the alternative measure for the inside debt and operating leverage, and across a range of tests designed to rule out the possibility that the primary findings are in any way driven by potential endogeneity. In addition, the findings demonstrate that the presence of manager-shareholder agency conflicts can strengthen the inside debt–DOL relationship suggesting the strong role of inside debt in reducing firm risk. Research limitations/implications Findings in this paper have implications for design of compensation structures so that corporate boards can establish incentives as a tool for risk management. A limitation of this study is that it is focused on one market, i.e. US listed companies, so the findings may not be applicable on a global scale. Originality/value To the best of the authors’ knowledge, this is the first study that links firm-level management of operating leverage through design of CEO inside debt incentives (two obvious choices for risk-reduction at the CEOs’ disposal include reducing financial risk through reduction of firm leverage and reducing operating risk through reduction of operating leverage). While use of firm leverage as an instrument of choice has been explored in the past, use of operating leverage to achieve risk reduction when CEO possess high inside holding, has received very little attention.

Playing for Keeps: CEO Incentive Horizon and Executive Departure

Playing for Keeps: CEO Incentive Horizon and Executive Departure

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.

Restricting CEO pay backfires: Evidence from China

AbstractUsing the pay restriction imposed on CEOs of centrally administered state‐owned enterprises (CSOEs) in China in 2009, we study the effects of limiting CEO pay. Compared with CEOs of firms not subject to the restriction, the CEOs of CSOEs experienced a significant pay cut. In response to the pay cut, CEOs increased the consumption of perks and siphoned off firm resources for their own benefit. Pay‐performance sensitivity for these firms also significantly decreases. The performance of these firms dropped following the pay restriction. Our findings suggest that restricting CEO pay distorts CEO incentives and brings unintended consequences. Our findings caution against limiting CEO pay.