Executive Compensation Contracts Research Articles

Government intervention and executive compensation contracts of state-owned enterprises: empirical evidence from China

This paper attempts to examine the impact of government intervention on executive compensation contracts by employing the data of listed companies in the Chinese equity market. The results show that redundancy burden caused by government intervention significantly reduces the compensation-performance sensitivity of executives in state-owned enterprises (SOEs), increases the level of compensation stickiness and leads to more executive perks. However, there is no evidence to support this conclusion in non-SOEs. Our results indicate that government has great responsibility for redundancy in SOEs and has a significant impact on the design of executive compensation contracts, but has limited impact on that of non-SOEs. Therefore, the impact of redundancy burden on executive compensation contracts is different between SOEs and non-SOEs. Our findings have important implications for the relationship between property rights and corporate performance, the formation mechanism of redundancy, and the impact of redundancy burden on executive compensation contracts.

Some unpleasant general equilibrium implications of executive incentive compensation contracts

Abstract We consider a simple real business cycle model in which shareholders hire self-interested executives to manage their firm. A generic family of compensation contracts similar to those employed in practice is studied. When compensation is convex in the firmʼs dividend, an increase in the firmʼs output results in a more than proportional increase in the managersʼ income. Incentive contracts of sufficient yet modest convexity are shown to result in an indeterminate general equilibrium, one in which business cycles are driven by self-fulfilling fluctuations in managersʼ expectations. The proposed family of contracts may yield first-best outcomes for specific parameter choices.

Do Compensation Clawback and Holdback Provisions Change Executive Reporting Choices?

The Dodd-Frank Act requires firms to include a clawback or holdback clause in executive compensation contracts. Using an experiment, we examine how executives react to the enforcement of these clauses after a restatement. We find that executives generally reduced the riskiness of their financial reporting choices after enforcement. An exception was executives who made relatively conservative reporting choices prior to the restatement. Amongst these executives, those covered by a clawback clause made riskier reporting choices after the restatement than those covered by a holdback clause. Theory argues and supplemental analysis supports that this effect is due to executives becoming angry when they did not feel responsible for the restatement, but were nevertheless required to physically return their bonus. Our results are important because they provide evidence about how executives react to the enforcement of a clawback or holdback clause, and where their reactions might produce unintended consequences.

The effect of conference calls on equity incentives: An empirical investigation

Conference calls have become increasingly common in recent years, yet there is little empirical evidence regarding the effect of conference calls on executive compensation. In this study, we examine the effect of voluntary disclosures on equity incentives. We hypothesize that voluntary disclosures, as measured by conference calls, affect executive compensation contracts. Using a dataset of 6263 firm-year observations from both conference call and non-conference call firms, our results are consistent with the argument that the board of directors substitutes voluntary disclosures for more costly corporate governance mechanisms. Alternatively, in firms where CEOs have less equity incentives, the owners demand more voluntary disclosures. The results of this study should be of great importance to executives and capital market participants internationally, such as investors and analysts, since we provide evidence that conference calls affect incentive based compensation contracts, which were shown in prior studies to be value relevant.

Valuation Consequences of Clawback Provisions

ABSTRACT:We investigate the degree to which including a clawback provision in executive compensation contracts is an effective governance mechanism by documenting the impact of clawback adoption on stock prices. We expect this ex post settling-up mechanism to be beneficial because it diminishes financial reporting risks. In support of our hypotheses, we find that the shareholders of adopting firms experience statistically significant positive stock-valuation consequences relative to propensity-score-matched control samples. Further, firms with previous financial restatements had the largest economic gains, suggesting that a clawback policy can be effective at curtailing incentives for earnings manipulation. Analysis of the bid-ask spread provides evidence that these provisions contribute to reducing financial reporting risk for restating firms, while non-restating firms experience no change in the spread. We find no evidence that clawback provisions entail costs in the form of higher CEO compensation following adoption nor do they influence the design of compensation contracts.JEL Classifications: G30; G34; G38; K12; K22.Data Availability: Data are available from sources identified in the paper.

Indexing Executive Compensation Contracts

We analyze the efficiency of indexing executive pay by calibrating the standard model of executive compensation to a large sample of US CEOs. The main finding is that benefits from indexing stock options are small and that fully indexing them would increase compensation costs by more than 50% for plausible scenarios. We show analytically that indexing the strike price of stock options to the stock market induces four different adjustments relative to standard options, which simultaneously affect the risk-sharing and incentive properties of the contract; theoretically, the overall effect is ambiguous. Calibration analysis shows that indexing is generally inefficient, because it destroys incentives for almost all CEOs except those of high-beta, high-volatility firms. This result also applies to a scenario in which CEOs can extract rents. An important implication of our findings is that the prevalence of “pay for luck” in observed equitybased compensation contracts can be explained by the fundamental trade-off between risk and incentives. Standard proposals to index contracts would often not improve the efficiency of compensation.

Clawbacks and Cronyism: Evidence from China

This paper is the first to examine the long‐term impact on bank lending policy of clawbacks in executive compensation contracts. Using a hand‐gathered database of Chinese business lending, we find evidence of reduced cronyism at the Big Four Chinese banks during the period after the introduction of a clawback program, marking a shift from earlier studies covering earlier time periods that find evidence of widespread cronyism at the Big Four banks. Politically connected borrowers received fewer and smaller loans relative to non‐Big Four banks, consistent with a backlash against cronyism at the Big Four banks. In contrast, we find that cronyism persisted (i.e., politically connected borrowers received more and larger loans) at non‐Big Four Chinese banks where the clawback policy was not effective.

Capital structure and executive compensation contract design: A theoretical and empirical analysis

Compensation contracts including incentive instruments not only provide executives with positive incentives to increase shareholder wealth, but also create a negative value-dilution effect for existing shareholders. This study investigates this dilemma by conducting a benefit-cost analysis under a proposed structural form valuation framework. Our design mechanism shows that, given their firms’ current capital structure, shareholders are always capable of designing an optimal compensation contract to maximize their wealth. Due to the different research issue and assumptions, unlike findings of most previous studies, our model proposes that in a firm with a higher leverage ratio shareholders should provide a contract with higher incentive intensity for managers, and this proposition is supported by the empirical analyses which examine the sample of S&P index firms over the period 1992–2006 after adopting an updated fixed effects model.

Economic Determinants of the Voluntary Adoption of Clawback Provisions in Executive Compensation Contracts

We examine whether U.S. firms’ MA (2) firms that acquire targets with relatively poor accounting quality are more likely to adopt clawbacks; (3) clawbacks improve investor perception of MA and (4) executives are more responsive to the market when completing M&A deals if their compensation contracts include clawbacks. These results suggest that boards take a pro-active approach and consider factors that may lead to restatements when adopting clawbacks. Our results have implications for U.S. policymakers, as the Dodd-Frank Act of 2010 requires mandatory adoption of clawbacks. Our results also suggest that non-U.S. firms can reduce managerial incentives to manipulate post-takeover earnings by using clawbacks.

The Two Sides of Derivatives Usage: Hedging and Speculating with Interest Rate Swaps

AbstractExisting cross-sectional findings on nonfinancial firms’ use of derivatives that are usually interpreted as the result of hedging may alternatively be due to speculation. Panel data examinations can distinguish between derivatives practices that endure over time and are therefore more likely to result from hedging, and those that are more transient, thus more consistent with speculation. Our decomposition results indicate that hedging of interest rate risk is concentrated among high-investment firms, consistent with costly external finance. Simultaneously, firms appear to use interest rate swaps to manage earnings and to speculate when their executive compensation contracts are more performance sensitive.

CEO pay incentives and risk-taking: Evidence from bank acquisitions

We analyze how the structure of executive compensation affects the risk choices made by bank CEOs. For a sample of acquiring U.S. banks, we employ the Merton distance to default model to show that CEOs with higher pay-risk sensitivity engage in risk-inducing mergers. Our findings are driven by two types of acquisitions: acquisitions completed during the last decade (after bank deregulation had expanded banks' risk-taking opportunities) and acquisitions completed by the largest banks in our sample (where shareholders benefit from ‘too big to fail’ support by regulators and gain most from shifting risk to other stakeholders). Our results control for CEO pay–performance sensitivity and offer evidence consistent with a causal link between financial stability and the risk-taking incentives embedded in the executive compensation contracts at banks.

Stock Repurchases and Executive Compensation Contract Design: The Role of Earnings per Share Performance Conditions

ABSTRACT: We examine the link between firms’ stock repurchase activity and the presence of earnings per share (EPS) performance conditions in executive compensation contracts. Findings reveal a strong positive association between repurchases and EPS-contingent compensation arrangements. Further analysis suggests net benefits to shareholders from this association. Specifically, repurchasers experience larger increases in total payouts; the positive association between repurchases and cash performance is more pronounced for firms with EPS targets in the presence of surplus cash; undervalued firms with EPS targets are more likely to signal mispricing through a repurchase; and repurchasers with EPS conditions are associated with lower abnormal accruals. We find no evidence that EPS-driven repurchases impose costs on shareholders in the form of investment myopia.

Controlling shareholders’ tunneling and executive compensation: Evidence from China

Conflict of interests between controlling shareholders and minority shareholders could affect executive compensation contracts. In this paper, we use data on Chinese listed companies and show that controlling shareholders’ tunneling reduces the pay-performance sensitivity of executive compensation. These results suggest that while incentive payment schemes are generally adopted in Chinese listed companies, controlling shareholders who obtain private benefits from listed companies have less incentive to strengthen the relationship between executive pay and firm performance.

Proposed Lease Accounting Changes

Regulators have proposed changes to the existing lease accounting rules that will require the capitalization of all operating leases as assets and liabilities. This study investigated the impact of operating lease capitalization on the financial statements and 11 financial ratios in restaurant and retail firms from 2006 to 2008. Significant absolute and relative differences were found across and within the two industries. All 11 financial ratios related to interest coverage, leverage, and profitability will change significantly and dramatically for both industry sectors. The findings indicate that retail firms will be affected to a greater extent than restaurant firms. Within the restaurant industry, small restaurant firms will face significantly higher debt-related ratios than medium or large restaurant firms. Reconciling previous research, this study found firm size to be an important factor in explaining operating lease usage with small firms likely to use more operating leases than large firms. Restaurant and retail firms should evaluate the impact of the proposed standard on debt agreements and executive compensation contracts and plan for operating under the new rules.

Sticks or Carrots? Optimal CEO Compensation when Managers Are Loss Averse

ABSTRACTThis paper analyzes optimal executive compensation contracts when managers are loss averse. We calibrate a stylized principal‐agent model to the observed contracts of 595 CEOs and show that this model can explain observed option holdings and high base salaries remarkably well for a range of parameterizations. We also derive and calibrate the general shape of the optimal contract that is increasing and convex for medium and high outcomes and that drops discontinuously to the lowest possible payout for low outcomes. Finally, we identify the critical features of the loss‐aversion model that render optimal contracts convex.

The association between non-financial performance measures in executive compensation contracts and earnings management

Executive compensation, especially cash bonus compensation, has come under fire by the Securities and Exchange Commission (SEC), the US Federal government, and the media for its role in the current economic crisis. Specifically, the SEC has argued that some compensation packages provide incentives for risk-taking that may undermine shareholder value over the long-term. Short-term incentive payments to executives in the form of cash bonuses are mostly contingent on reaching targets of accounting-related measures or financial performance measures (FPMs). However, the incentives from these payments may lead to accrual manipulation and earnings management (EM). Alternative measures are non-financial performance measures (NFPMs). We expect that firms that employ NFPMs in bonus contracts will have a lower prevalence of EM, since these measures tend to focus executives on the long-term. In this paper, we examine the type of performance measures used by firms in the S&P 500 index in their cash bonus compensation. We find that firms that use both FPMs and NFPMs have lower discretionary accruals compared to firms that use only FPMs, consistent with lower income-increasing EM. However, we do not find evidence of a reduction in EM behavior using the incidence of meeting or just beating analyst earnings benchmarks, another common EM proxy. In additional tests on a subset of firms with equity offerings, in which incentives for income-increasing manipulation are likely high, we find that firms with NFPMs have lower discretionary accruals. The implication is that NFPMs can be used in compensation contracts to reduce EM behavior and mitigate erroneous executive compensation. This is important to investors as well as regulators, especially in light of the recent debate on compensation reform.

Determinants of CEO Pay: A Comparison of ExecuComp and Non-ExecuComp Firms

ABSTRACT: We document that firms included in the ExecuComp database tend to be larger, more complex, followed by more analysts, have greater stock liquidity levels, and have higher total, but less concentrated, institutional ownership than other firms. Based on these differences, we test and find support for three predictions. First, ExecuComp firms rely more heavily on earnings and stock returns in determining CEO cash compensation. Second, the weight on earnings is more sensitive to differences in the extent of growth opportunities for ExecuComp firms. Third, the positive relation between institutional ownership concentration and the value of stock option grants is stronger for ExecuComp firms. Overall, our results suggest that ExecuComp and non-ExecuComp firms operate in different contracting environments that lead to differences in the design of their executive compensation contracts. As a result, care should be taken in extending results based on ExecuComp samples to non-ExecuComp firms.

Pay me Right: Reference Values and Executive Compensation

This paper examines the importance of reference values for executive compensation contracts. We rely on a quasi-experimental setting (the adoption of pay guidelines), and a well-defined measure of individual-specific reference values to provide evidence on how a change in CEO reference compensation leads to subsequent changes of actual pay. We find that executive compensation adjusts gradually towards the new reference values, and that the speed of the adjustment depends on the corporate governance characteristics: the firm ownership structure, the role of the State and of the employees in the firm decision making. These results provide empirical support for theoretical models of bargaining that take into account reference values.

Relative Performance Evaluation and Related Peer Groups in Executive Compensation Contracts

ABSTRACT: This study examines the explicit use of relative performance evaluation (RPE) in executive compensation contracts and the selection of RPE peers. Using S&P 1500 firms’ first proxy disclosures under the SEC’s 2006 executive compensation disclosure rules, we find that about 25 percent of our sample firms explicitly use RPE in setting executive compensation. We demonstrate that a lack of knowledge of both actual peer-group composition and the link between RPE-based performance targets and future peer performance significantly hinder the traditional implicit test from detecting RPE use. We also find that firms consider both costs and benefits of RPE as an incentive mechanism when deciding to use RPE. Finally, both efficient contracting and rent extraction considerations influence RPE peer selection, with the relative importance of these competing considerations depending on RPE firms’ performance.

Relative Performance Evaluation and Related Peer Groups in Executive Compensation Contracts

This study examines the explicit use of relative performance evaluation (RPE) in executive compensation contracts and the selection of RPE peers. Using S&P 1500 firms’ first proxy disclosures under the SEC’s 2006 executive compensation disclosure rules, we find that 25.44 percent of our sample firms explicitly use RPE in setting executive compensation. We demonstrate that a lack of knowledge of both actual peer group composition and the link between RPE-based performance targets and future peer performance significantly hinder the traditional implicit test from detecting RPE use. We also find that firms consider both costs and benefits of RPE as an incentive mechanism when deciding to use RPE. Finally, both efficient contracting and rent extraction considerations influence RPE peer selection and the relative importance of these competing considerations depends on RPE firms’ performance.