Executive Compensation Contracts Research Articles

Non‐controlling shareholder activism and executive pay‐for‐performance sensitivity: Evidence from the over‐appointment of directors in the Chinese market

AbstractWe examine the impact of non‐controlling shareholder activism on the effectiveness of executive compensation contract, particularly focusing on the over‐appointment of directors in A‐share firms listed on the Shanghai and Shenzhen Stock Exchanges from 2008 to 2021. We discover that such over‐appointments by non‐controlling shareholders significantly promote executive pay‐for‐performance sensitivity of these enterprises. This effect becomes even more pronounced in enterprises that display a weaker government intervention and media attention. Further mechanism analysis indicates that over‐appointments improve the effectiveness of compensation contract by improving the quality of accounting information and restraining executives' opportunistic behaviour. Our further research finds that over‐appointments by non‐controlling shareholders can effectively reduce executive compensation stickiness, while significantly increasing the absolute salary level of executives. There is no evidence to suggest that independent directors increase executive pay‐for‐performance sensitivity.

CSR contracting and stock price crash risk: International evidence

In this study, we examine whether and how the worldwide integration of corporate social responsibility (CSR) criteria into executive compensation contracts (hereafter, CSR contracting or CSR-based executive compensation) affects a firm’s stock price crash risk. Using a comprehensive sample of 42,049 firm-year observations from 53 countries from 2003 to 2019, we find that CSR contracting firms have greater stock price crash risk. This positive association can be attributed to exacerbated managerial bad news hoarding behavior and overinvestment. We further demonstrate that the positive relationship between CSR contracting and crash risk is more pronounced for firms with powerful CEOs, as well as in countries with inferior investor protection and disclosure transparency. Overall, our findings are consistent with the agency cost and managerial power perspective, suggesting that CSR contracting may be exploited by powerful and opportunistic managers as a means of diverting shareholders’ attention and concealing bad financial news. Our findings have implications for both researchers and business practitioners.

The role of inside debt in banks’ M&A choices: wealth expropriation or conflict resolution?

PurposeThis study investigates the impact of bank CEOs’ inside debt on shareholder benefits in the context of bank mergers and acquisitions (M&A) before the 2008–2009 financial crisis.Design/methodology/approachEmploying an event-study methodology, this analysis delves into market reactions to bank M&A announcements during 2006–2007, encompassing 105 M&As by 79 public commercial banks. This era witnessed heightened risk-taking behavior on the verge of the financial crisis. We explore the relation between relative inside debt and market abnormal returns at M&A announcements and the association between relative inside debt and cash payment preferences in M&As.FindingsEvidence suggests that M&A announcements from banks where acquiring CEOs hold a substantial inside debt experience favorable stock market reaction, particularly for smaller banks. Additionally, banks with elevated CEO inside debt tend to favor cash as a payment mode for M&As.Research limitations/implicationsOne limitation of this study is the short period of data availability. The data used in this study covers only 2006 and 2007, the periods marked by notable risk-taking activities on the verge of the financial crisis. Although this period is perfectly suitable for our investigation, given the prevalence of conflicts between equity and debt holders, it is essential to acknowledge that our findings may not capture changes or trends over time. Nevertheless, the results offer valuable insights into the factors that influence the behavior of the studied population. Future research could employ a longitudinal design to address this limitation and gain a more comprehensive understanding of the dynamics over extended periods.Practical implicationsOur study has significant implications for businesses and policymakers as it provides insights into the factors contributing to financial crises and how compensation mechanisms can be used to moderate bank risk-taking. We propose that CEO inside debt compensation presents a plausible mechanism that boards of directors can incorporate into bank executive compensation contracts. By doing so, they can promote value-enhancing investments and moderate excessive risk-taking, thereby safeguarding the financial stability of individual banks and overall financial system.Originality/valueOur study sheds light on the beneficial role of bank CEO inside debt for shareholders, contributing empirical backing to the conflict resolution viewpoint in the discourse on wealth appropriation. From a regulatory stance, our findings advocate for the inclusion of bank CEO inside debt in executive remuneration agreements. Such a strategy can empower boards of directors to mitigate undue risk and enhance shareholder value in M&As, safeguarding both individual bank and broader financial system stability.

Relationship Banking and Firms’ Earnings Quality – Does it Matter Whether Banks are Creditors or Owners?

There is mixed empirical evidence on whether close banking relationships are associated with lower or higher earnings quality of borrowing firms. This paper analyzes how this evidence can be explained by the role of the bank, whether the bank is a creditor or equity-holder of the firm. We use a sample of Japanese public firms. In Japan, (1) banks historically have both close financial and personal ties to borrowing firms, (2) banks are not only lenders, but are also permitted to have an equity stake in the firm, and (3) detailed data on bank relationship characteristics are publicly available.One key result is that relationship banking is associated with lower earnings quality if the bank only provides debt. This effect is more pronounced in years of economic expansion. The results are in line with the theoretical literature, which argues that borrowing firms that want to conceal good performance from competitors benefit from relationship banking because banks’ access to private information lowers the demand for high earnings quality. However, if banks have an equity stake, they are more concerned about complying with insider-trading rules and governing agency problems of equity by efficient executive compensation contracts. Consistently, the second main finding is that the firm's earnings quality improves significantly with a bank's equity stake, regardless of the state of the economy. These results are robust according to various specifications of relationship banking or earnings quality.

Voluntary Performance Disclosures in the CD&A

ABSTRACT This paper examines voluntary disclosure in the context of shareholder scrutiny of executive compensation contracts. We find that firms voluntarily increase discussion of their performance within their CD&A disclosures when peer-benchmarked compensation relative to performance is high. In contrast, we do not find a similar increase in performance discussion in the corresponding MD&A disclosures, which suggests that the effect is not driven by firms’ general disclosure practices. We also find that the relation between relatively high compensation and CD&A performance disclosure strengthens following the implementation of mandatory Say-on-Pay, which increased costs associated with investor criticism of pay. These disclosures appear to be used effectively to avoid negative compensation assessments, in that they are associated with higher levels of shareholder and proxy advisor approval. Altogether, our findings suggest that CD&A performance disclosures allow firms to communicate the context of their compensation choices to improve shareholder opinions of pay. Data Availability: Data are available from the public sources cited in the text. JEL Classifications: D22; J33; M41.

Executive compensation horizon incentives, performance targets, and auditor risk assessment

Shorter compensation duration can induce executives to act myopically and manage earnings to boost short-term firm performance. Such earnings management activities increase financial statement misstatement risk and, therefore, audit risk. Using audit fees as a proxy for auditors’ risk assessments, we investigate whether auditors consider executives’ compensation horizon incentives in assessing audit risk. We find that shorter executive compensation duration is associated with higher audit fees. However, auditors also consider other elements of the executive compensation contract when assessing audit risk. Specifically, we find that when executive compensation includes performance-vesting grants, auditors pay less attention to compensation duration and perceive companies that meet or just beat performance targets as riskier (and thus charge them higher fees). Overall, our findings suggest that auditors adopt a nuanced approach to the audit risks posed by executive compensation contracts.

Are ESG performance-based incentives a panacea or a smokescreen for excess compensation?

PurposeThis paper aims to examine how the use of environmental, social and governance (ESG) incentives intersects with top management power and various corporate governance mechanisms to affect excess annual cash bonus compensation.Design/methodology/approachThe authors use a novel artificial intelligence (AI) technique to obtain data about ESG incentives use by firms in the S&P 500. The authors test the hypotheses with an endogenous treatment-regression and a contrast test.FindingsWhen the top management team has power and uses ESG incentives, there is a 32% reduction in excess annual cash bonuses implying ESG incentives are an effective corporate governance tool. However, nuanced analyses reveal that when powerful management teams with ESG incentives are from environmentally sensitive industries, have a corporate social responsibility (CSR) committee or have long-term view institutional shareholders, they derive excess bonuses.Practical implicationsStakeholders will better understand management’s motivations for the inclusion of ESG incentives in executive compensation contracts and be able to identify situations which require closer scrutiny.Social implicationsGiven the increased popularity of ESG incentives, society, regulators, boards of directors and management teams will be interested in better understanding when these incentives might be effective and when they might be abused.Originality/valueTo the best of the authors’ knowledge, this study is the first to examine the use of ESG incentives in relation to excess pay. The authors contribute to both the CSR and executive compensation literatures. The work also uses a new methodological technique using AI to gather difficult-to-obtain data, opening new avenues for research.

Minority shareholder activism, threat of exit and pay-performance sensitivity

This study investigates whether and how minority shareholders activism (MSA) affects executives’ pay–performance sensitivity (PPS). Based on annual data of listed companies on SSE and SZSE from 2010 to 2021, we find that MSA significantly promotes executives’ pay-performance sensitivity, through the mechanism of disciplining management with exit threats. Such effect is prominent only for non-SOE firms. The results are robust after mitigating endogeneity issues and using one-period-lagged MSA. Our findings indicate that minority shareholder activism plays an important role in improving the effectiveness of executive compensation contracts.

Alignment between Compensation-Contracting and Value-Relevance Roles of Revenues

ABSTRACT Revenue is the closest proxy in financial statements for market size and dominance, factors that determine the survival and future profits of modern corporations. Hence, revenue may contain value-relevant information, incremental to information contained in earnings. We find that revenue is used as a performance metric in executive compensation contracts when it provides information on equity valuation beyond the information provided by earnings. We call this occurrence an alignment between revenues’ contracting and the valuation roles. The alignment is higher for firms in newer industries, with investors who focus on revenue targets, with managers who provide revenue guidance, and with analysts who issue revenue forecasts. This alignment seems efficient because revenue is more informative of future profits when it carries higher weight in executive compensation contracts. We conclude that modern corporations increasingly incentivize managers to create new markets and defend existing market shares, in addition to maximizing current profits. JEL Classifications: J3; L2; M41.

Executive Compensation Tied to ESG Performance: International Evidence

ABSTRACTUsing a wide sample of international publicly traded firms, this paper studies the rapidly increasing practice of incorporating Environmental, Social, and Governance (ESG) metrics in executive compensation contracts. Our evidence suggests that this compensation practice varies at the country, industry, and firm levels in ways that are consistent with efficient incentive contracting. We also observe that reliance on ESG metrics in executive compensation arrangements is associated with engagement, voting, and trading by institutional investors, which suggests that firms could be adopting this practice to align their management's objectives with the preferences of certain shareholder groups. Finally, we find that the adoption of ESG Pay is accompanied by improvements in key ESG outcomes, but not by improvements in financial performance.

Executive Compensation Complexity and Firm Performance

How does the complexity of executive compensation contracts affect firm performance? With unknown consequences, the compensation complexity of executives has been rising. We define and measure executive compensation complexity and relate it to accounting, market, and ESG (i.e., environmental, social, and governance) metrics of firm performance. CEO compensation complexity negatively affects all three types of firm performance. We explore theoretical explanations for this relationship and find that cognitively complex CEOs can better deal with complex contracts. The negative complexity effects disappear if firms use only financial goals. Complexity is more harmful in unstable and munificent industries. Complexity also mitigates the negative effect of CEO tenure on long-term performance. In addition, firm performance suffers if the top management team members have heterogeneously complex contracts. Robustness checks support these findings. We conclude that the trend of adding more metrics to executive compensation contracts is not a generally preferable solution to the new and more intense agency problems that firms encounter.

Strength in numbers: Minority shareholders' participation and executives' pay-performance sensitivity

This study investigates the effects of minority shareholders' participation in annual general meetings (AGMs) on executives' pay–performance sensitivity (PPS) in a Chinese stock market. Using a novel dataset of minority shareholders' attendance of AGMs, we find that the number of attendees is significantly and positively associated with PPS. The results are robust to the instrumental variable approach, placebo tests, excluding the effect of shareholdings, and using alternative measures of attendance and PPS. We also examine two possible channels and find that the positive effect of minority shareholders' attendance on PPS is mainly driven by the compensation contracting channel, that is, by incorporating more voices from retail investors and independent directors into the compensation contract design, than by the compensation justification channel. Extended analyses show that the impact of minority shareholders' attendance is more pronounced in state-owned enterprises (SOEs) and in regions with good investor protection than in non-SOEs and regions with poor investor protection. Additional analyses also find higher minority shareholders' attendance leads to lower executive perk consumption. Overall, our findings highlight the importance of minority shareholders' participation in AGMs and their governance role in the design of executive compensation contracts.

Corporate governance of the parent company and executive compensation contracts in subsidiary firms: Evidence from China

ABSTRACT This paper studies whether the corporate governance of the parent company affects the executive compensation contract of its listed subsidiaries. Based on a quasi-natural experiment on the board reforms in the Chinese central state-owned enterprises (CSOEs), which improves the corporate governance in the ultimate parent company, we find the following: (1) The improved corporate governance of the parent company can effectively restrain the managerial power of listed subsidiaries and reduce excess managerial pay. (2) The above-documented effect is more pronounced when cash flow rights (the wedge between control rights and cash flow rights) of the ultimate parent company is low (high), or when the listed company is at the bottom of the pyramid, or when the managerial power of the subsidiary firm is higher. (3) The improved corporate governance of the parent company can also effectively alleviate managerial perk consumption and the executive–employee compensation gap at their listed subsidiaries. This study suggests that the governance improvement in ultimate parents has a spillover effect in that it enhances the governance at their listed subsidiaries.

Are CEOs rewarded for managerial ability? Evidence from nonprofit hospitals

PurposeMost prior studies investigating determinants of CEO compensation in nonprofit hospitals ignore how managerial ability affects compensation. This study aims to examine whether CEOs with greater ability to manage corporate resources efficiently receive more payment in nonprofit hospitals.Design/methodology/approachThis study employs a sample of 764 observations from 85 Pennsylvania nonprofit hospitals for the period 2010–2020.FindingsThis study finds a positive and statistically significant association between managerial ability and CEO compensation. The results are robust to alternative measures of managerial ability.Practical implicationsThe measure of managerial ability proposed in this study could be used by boards of directors to quantify, evaluate and benchmark CEO ability. The results are also relevant to policymakers, stakeholders and the public interested in understanding the determinants of CEO compensation in nonprofits.Originality/valueThis study is among the first to use a more precise measure of managerial ability, which captures the unobserved manager-specific aspects of CEO ability. In addition, this study contributes to the literature by providing evidence that CEO's ability to manage hospital resources efficiently plays an essential role in designing executive compensation contracts.

Emission taxation, green R&D, and managerial delegation contracts with environmental and sales incentives

AbstractWe extend the analysis of a managerial delegation model with green R&D by incorporating two explicit incentive‐based executive compensation contracts. In the combination of environmental and sales delegations, (i) the incentives are higher than those under a single incentive scheme, (ii) firms' output and abatement efforts are higher, and (iii) total emissions are lower, and (iv) a firm's profits are higher than that under a sales delegation. Therefore, an emission tax policy, along with firms' compensation packages related to environmental delegation, can play a key role in curving market failure and improving welfare.

Stock-Based Compensation and Insider Trading with Liquidity Signal

We study a stock-based executive (CEO) compensation contract for the case where the insider receives a signal about the demand of liquidity traders in the stock market. The singleperiod model of Kyle (1985) is adopted for deriving the stock market equilibrium. Based on the equilibrium stock price, the optimal linear contract for executive compensation is obtained by applying a standard principal-agent model. Surprisingly, it is found that the firm’s liquidation value is not used in the optimal executive compensation contract in both our model and the benchmark model (where there is no signal about liquidity). We also make comparative statics for the equilibrium stock price and the optimal executive compensation contract with respect to exogenous parameters.

Female board representation and the adoption of corporate social responsibility criteria in executive compensation contracts: International evidence

This paper examines the relation between female board representation and the adoption of corporate social responsibility (CSR) criteria in executive compensation contracts (i.e., CSR-based executive compensation) in an international setting. Considering the greater propensity of female directors to have CSR-oriented values, expertise and experience compared to male counterparts, the increased presence of female directors could breed greater board sensitivity to CSR issues and bring valuable human capital to the board that helps address CSR-related concerns. Therefore, we expect that increased board female representation is associated with an increased firm tendency to offer CSR-based executive compensation. Using a comprehensive sample of 41,236 firm-year observations from 59 countries during the period 2002–2018, we find a positive effect of female board representation on the likelihood of a firm adopting CSR-based compensation. Several methods are applied to rigorously address potential endogeneity concerns. Further, our cross-country moderating analyses indicate that the positive relation is more pronounced in countries with greater gender equity for senior positions and in countries with a lower degree of masculine culture. We also show that with greater female director representation, the use of CSR-based executive compensation is more conducive to enhancing CSR performance and firm value. Overall, this study sheds light on the effectiveness of introducing female directors in reinforcing the CSR orientation at the firm leadership level in a global context, which has implications for both business practitioners and researchers.

Institutional investors' corporate site visits and pay-performance sensitivity

This study investigates whether and how institutional investors' site visits affect executive compensation contracts. Using Chinese listed firms on the Shenzhen Stock Exchange from 2013 to 2018, we find that institutional investors' site visits significantly promote executives' pay-for-performance sensitivity (PPS), and this effect is prominent only for firms with a more powerful CEO and for private firms. The results are robust after controlling for alternative explanations and mitigating endogeneity issues. Furthermore, the positive relationship between site visits and PPS is significant only for firms with more receptionists attending visits, more senior executives participating in investor receptions, and more site visits conducted in peak months. Mechanism analysis suggests that investors can motivate executives to take more risks and improve firm information transparency, ultimately increasing PPS. Overall, our findings indicate that investor site visits play an important role in improving the effectiveness of executive compensation contracts.

Chief Audit Executive as Supervisory Board Member and Executive Compensation Contracts

This paper studies a unique phenomenon in China's corporate governance—that chief audit executives (CAEs) sit on supervisory boards (CAE duality)—and examines its effects on executive compensation contracts. Using a sample of listed firms between 2010 and 2018, we find a significant positive relation between CAE duality and pay‐for‐performance sensitivity, which suggests that the dual position helps integrate monitoring resources and reduces agency costs. This positive relation is more pronounced when companies face a stricter monitoring environment and in non‐state‐owned enterprises (non‐SOEs) than in SOEs. In addition, we find that the recent reforms on compensation strengthen the role of CAE duality in SOEs. Further analysis identifies the reliability of performance information (i.e., earnings quality) and reduced executive self‐interested behaviours (i.e., perquisite consumption) as the influencing mechanisms that increase the demand for performance‐based compensation and thus improve pay‐for‐performance sensitivity.

The Power of Numbers: Base‐Ten Threshold Effects in Reported Revenue*

ABSTRACTWe show that managers have a propensity to disproportionately report total revenues just above base‐ten thresholds (e.g., 10 million, 30 million, 1 billion) and examine motives for and consequences of this behavior. Focusing on base‐ten thresholds in revenues is important because, despite being unusually prevalent in revenue targets set in executive compensation contracts, analyst forecasts, and management forecasts, they have not been previously explored. We also show that pressure to beat these targets provides one explanation for the base‐ten bias in reported revenues. However, these incentive effects do not offer a complete explanation because base‐ten threshold‐beating is observed even in the absence of these explicit targets. We further find that when firms beat a base‐ten threshold for the first time, they experience increases in news coverage, institutional ownership, liquidity, and analyst following, even after controlling for whether they have beaten other common benchmarks. These results suggest that managers also beat base‐ten thresholds in order to increase their firms' overall visibility. Overall, we show that a preference for base‐ten numbers, which have no inherent economic meaning, has a measurable effect on the actions of market participants. These results open the door to a new range of managerial targets previously unexplored.