Managerial Compensation Schemes Research Articles

Corporate Social Responsibility and Managerial Compensation: Further Evidence from Spanish Listed Companies

Ongoing regulatory efforts aim to link managerial compensation with a firm’s performance. However, little is known about whether and how Corporate Social Responsibility (CSR) goals are considered in the design of the managerial compensation scheme. This paper addresses this research question by analyzing a sample of Spanish listed firms for the period spanning 2013–2018. The outcomes of the regressions suggest that there is a positive relationship between CSR and the managerial compensation, but this relationship is significant only with lower levels of CSR. The study also reveals that CSR is positively associated with the proportion of equity-based compensation and, therefore, negatively associated with the proportion of cash-based compensation. In all, our results suggest that firms with lower levels of CSR, likely following social pressures, seek to improve their investments in CSR; and, in doing so, they design a managerial compensation scheme that incentivizes the manager to meet the firm’s goals related to CSR investments. Hence, since CSR is associated with an increase in the long-term firm’s value, the equity-based component of the managerial scheme is higher than in the remaining firms. However, the high proportion of cash-based compensation is far from the desirable goals promoted by the Governance Codes.

How To Prevent a New Global Financial Crisis

The main issue addressed in this paper is whether a new financial crisis can be avoided.After reviewing the key elements that were present in the 2007/2009 financial crisis, there is an analysis of the regulatory reforms which took place during and after the financial meltdown. The role played in it by the shadow banking system and the regulatory reforms dealing with it deserve particular attention.The regulatory reforms are assessed in the context of systemic risk and run vulnerability in order to recommend what should be done to prevent a new financial crisis from happening. The main conclusions are: 1) A key issue to avoid a new financial crisis is to prevent an excessive concentration of loans in any one sector, region or kind of assets of the economy.2) The role of the central bank as lender of last resort should be reassessed in light of the experience of what has been done in the context of the COVID-19 pandemic. 3) In order to prevent managers from taking excessive risks using other people´s money, managerial compensation schemes should be changed. 4) Issues which have to do with the conflict of interests in the credit rating agencies are still waiting for better regulation.5) After the failure of mainstream economic theory, it is time to reevaluate the contributions of authors like Keynes, Kindleberger and Minsky on the subject of economic crisis.

Performance feedback and organizational learning: the role of regulatory focus

PurposeThis study investigates how a firm's regulatory focus (i.e. promotion and prevention foci) affects growth- and efficiency-oriented strategic change, highlighting the role of organizational-level regulatory focus as a cognitive frame within which to interpret performance feedback and its subsequent effects on strategic decisions.Design/methodology/approachThe authors collected longitudinal data on 98 S&P 500 manufacturing firms for a seven-year period. The panel data, which includes texts from the firms' 10-K filings, were then analyzed using a feasible generalized least squares (FGLS) regression estimator to test the authors’ hypotheses.FindingsA firm's strategic change orientation is affected by its regulatory focus and performance feedback: a promotion focus increases the magnitude of growth-oriented strategic change, while a prevention focus favors efficiency-oriented strategic change. Furthermore, both foci moderate the effect of performance feedback on the strategic change orientation: under negative performance feedback, a promotion (prevention) focus increases (decreases) the magnitude of growth-oriented strategic change relative to that of efficiency-oriented change. The findings provide robust evidence that regulatory focus can influence how organizations learn from feedback and formulate strategic change.Research limitations/implicationsThe authors’ examination of regulatory focus and organizational learning process relied on large manufacturing firms in the USA. However, learning process could be quite different in small and/or young firms. Future work should expand to a wider range of organizational types, such as nascent entrepreneurial ventures. In addition, the authors’ measurement of regulatory focus using corporate text has inherent weakness and could be supplemented with alternative research methods, such as surveys, interviews or experiments. All in all, however, the findings of this study offer a novel behavioral perspective while demonstrating that a regulatory focus is an important antecedent of organizational learning.Practical implicationsThis study highlights the importance of motivational characteristics of the top managers in the process of organizational learning from performance feedback. Furthermore, recruitment of a new top manager should be aligned with the organizational context, values and goals. In addition, corporate governance systems such as managerial compensation schemes need to be carefully designed so as to maximize organizational resilience, especially in the context of performance downturn or environmental change. Establishing a constructive organizational culture so that strategic decisions are not overly swayed by the performance outcomes would also be crucial to the organizational learning process.Social implicationsThis study highlights the importance of understanding the motivational orientations of top managers in organizational learning. In terms of managerial compensation, for instance, an optimal incentive system should reflect the desired performance output by encouraging managerial behavior that corresponds to its objective. Furthermore, motivational orientation of new recruits should be considered in the context of the composition of the top management team members in order to achieve “optimal fit.” In addition, this study suggests that top executives' regulatory focus can be a key factor for organizations in balancing goals of different value orientations.Originality/valueThe findings of this study demonstrated that a firm-level regulatory focus has a significant effect on organizational learning and strategic change following performance feedback. The authors hope this study provides an impetus for future discussions on the microcognitive mechanisms of organizational learning by exploring the relations between organizations' regulatory foci, performance feedback and strategic change orientations.

Multilevel optimal managerial incentives and audit fees to limit earnings management practices

The main objective of this study is to design an optimal managerial compensation scheme and optimal auditor fees to counter income-increasing earnings management behavior. This study draws on game theory with three players: the shareholders, managers and auditors. It considers the possibility of collusion between the manager and auditor and analyzes the different scenarios that may exist between the three players. The results of our study prove that it is possible to establish an optimal managerial compensation contract and optimal auditor fees which will limit earnings management manipulation and guarantee high audit quality. We found that the optimal managerial compensation scheme depends on the firm situation. Moreover, we illustrated how the auditor is motivated by improving audit effort in all possible scenarios. This paper can be considered a tentative effort to provide systematic evidence for designing optimal contracts that align divergent interests between managers and shareholders.

Endogenous managerial compensation contracts in experimental quantity-setting duopolies

Given the ongoing debate on managerial compensation schemes, our paper offers empirical insights on the strategic choice of firms' owners over the terms of a managerial compensation contract, as a commitment device aiming at gaining competitive advantage in the product market. In a quantity setting duopoly we experimentally test whether firms' owners compensate their managers through contracts combining own profits either with revenues or with relative performance, and the resulting managerial behaviour in the product market. Prominent among our results is that firms' owners choose relative performance over profit revenue contracts more frequently. Further, firms' owners successfully induce a more aggressive behaviour by their managers in the market, by setting incentives which deviate from strict profit maximization.

The Unintended Consequences of Divestment

Large divestment campaigns are undertaken in part to depress share prices of firms that investors see as engaged in harmful activities. We show that, for two reasons, these campaigns may be ineffective, even if they are large. First, they are self-defeating: because investors who divest earn lower and riskier returns than those that do not, they control a decreasing share of wealth over time, leading to the failure of even initially successful campaigns. Second, we show that, for standard managerial compensation schemes, divestment campaigns actually provide an incentive for executives to increase, not reduce, the harm that they create, making them counter-productive. Executives are induced to accede to campaigners' demands only if provided with more expensive contracts that reward short-termism. As short-termist contracts reduce shareholder welfare, they can only be implemented if campaigners control corporate boards, a goal directly contrary to the act of divestment.

Board size and firm risk-taking

The main purpose of this paper is to investigate the relevance of board size and firm’s risky policy choices. I find that both the managerial pay to performance sensitivity (delta) and the managerial pay to firm risk sensitivity (vega) are negatively related to board size, suggesting that small boards give CEOs larger incentives and force them to bear more risk than larger boards. While controlling for the effects of managerial compensation schemes on corporate investment policy and financing policy, I find that companies with smaller boards take lower leverage but more risky investment. Finally, after controlling for the effects of financial decisions on overall firm risk, I find that companies with smaller boards are associated with higher future risk. This supports the hypothesis that board size has negative impact on firm’s risk taking. My results are robust to various estimation methods that control for endogeneity and panel dynamics.

Risk-Taking by Banks: What Did We Know and When Did We Know It?

The composition of risks assumed by U. S. commercial banks underwent a dramatic transformation over the years leading up to the financial crisis: between 2000 and 2006 idiosyncratic risk dropped by almost half while systematic risk doubled. These patterns, more pronounced in banks with heavy involvement in residential mortgage lending and securitization, were accompanied by higher earnings per share performance. The stock market's response to these changes was, however, not uniformly enthusiastic. Banks heavily engaged in residential mortgage lending started exhibiting lower earnings response coefficients and had lower stock returns even prior to the crisis. Their managers, on the other hand, earned signi ficant amounts through compensation plans heavily geared to short-term earnings. Our analysis provides strong support for the view that, even though fi nancial markets were able to identify banks engaging in excessively risky lending activity long before the onset of the financial crisis, managerial compensation schemes failed to respond eff ectively to dramatic changes in the risk taking environment engendered by increased levels of securitization.

Stock trading, information production, and executive incentives

This paper investigates the effect of stock market microstructure on managerial compensation schemes. We propose and empirically demonstrate that the sensitivity of chief executive officer's (CEO's) compensations to changes in stockholders' value is higher when the stock market facilitates the production and aggregation of private or public information. Using stock trading data and analysts' earnings forecast data, we construct five different measures of the information content in stock prices. These measures, separately and jointly, account for the cross-sectional variations in CEO pay-performance sensitivity well. Our results are robust to the choice of samples, incentive measures, model specifications, and estimation methods. We extend the analysis to non-CEO executives and executive teams and find similar results.

Stock Market Information Production and Executive Incentives

This paper investigates the effect of stock market microstructure on managerial compensation schemes. We propose and empirically demonstrate that the sensitivity of chief executive officer's (CEO's) compensations to changes in stockholders' value is higher when the stock market facilitates the production and aggregation of private or public information. Using stock trading data and analysts' earnings forecast data, we construct five different measures of the information content in stock prices. These measures, separately and jointly, account for the cross-sectional variations in CEO pay-performance sensitivity well. Our results are robust to the choice of samples, incentive measures, model specifications, and estimation methods. We extend the analysis to nonCEO executives and executive teams and find similar results.

Signaling With Mandatory Dividends: The Case of the Greek Stock Market

We explore the effect of dividend announcements on stock market returns in the context of an event study. Our sample consists of firms paying the minimum required dividend and firms paying above the required minimum. In Greece, tax wise, dividends are treated equally with capital gains and corporate management is controlled by major shareholders to a large extend. Controlling for managerial moral hazard and the degree of back- and frontloading of the managerial compensation scheme, our theoretical model predicts that with known assets in place and asymmetric information on reinvestment prospects, unexpected dividend increases result in negative abnormal returns. Also, the higher the expectations of investors about reinvestment prospects, the lesser the impact on the stock price when firms announce the minimum required dividend. These theoretical predictions are corroborated from our empirical findings. Announcements when minimum dividend is paid have no signaling effect providing prima facie evidence that dividends contain new information not embedded in contemporaneous earnings announcements.

Organizational Design and the Intensity of Rivalry

We analyze the effect of managerial compensation schemes and organizational structure on competitive behavior in imperfectly competitive product markets. Previous research suggests that in cases of strategic substitutability, firms tend to choose organizational structures and compensation systems that commit the firm to behaving aggressively in the product market, reducing firm and industry profits. In contrast, we show that while compensation and structure in isolation lead to excessive aggressiveness, the combination of these two internal choice variables may reverse the outcome—organizational design can be used as a commitment device to reduce competitive rivalry. Finally, we find that in equilibrium, firms may choose to be different; one firm is decentralized and uses incentives that commit it to being aggressive, while the other is centralized and uses incentives that commit it to being soft. Hence, endogenous firm heterogeneity in the form of organizational differentiation allows firms to avoid a mutually detrimental outcome.

Managerial incentives and risk-taking

We provide empirical evidence of a strong causal relation between managerial compensation and investment policy, debt policy, and firm risk. Controlling for CEO pay-performance sensitivity (delta) and the feedback effects of firm policy and risk on the managerial compensation scheme, we find that higher sensitivity of CEO wealth to stock volatility (vega) implements riskier policy choices, including relatively more investment in R&D, less investment in PPE, more focus, and higher leverage. We also find that riskier policy choices generally lead to compensation structures with higher vega and lower delta. Stock-return volatility has a positive effect on both vega and delta.

Risk-taking incentives of executive stock options and the asset substitution problem

Various theoretical models show that managerial compensation schemes can reduce the distortionary effects of financial leverage. There is mixed evidence as to whether highly levered firms offer less stock-based compensation, a common prediction of such models. Both the theoretical and empirical research, however, have overlooked the leverage provided by executive stock options. In principle, adjusting the exercise prices of executive stock options can mitigate the risk incentive effects of financial leverage. We show that the near-universal practice of setting option exercise prices near the prevailing stock price at the date of grant effectively undoes most of the effects of financial leverage. In a large cross-sectional sample of Canadian option-granting firms, we find evidence that executives' incentives to take equity risk are negatively rather than positively related to the leverage of their employers.

Executive Compensation and Managerial Risk-Taking

This paper provides empirical evidence of a strong relation between the structure of managerial compensation and both investment policy and debt policy. Higher sensitivity of CEO wealth to stock volatility (vega) is associated with riskier policy choices, including relatively more investment in R&D, more focus on fewer lines of business, and higher leverage. These results are consistent with the hypothesis that higher vega in the managerial compensation scheme gives executives the incentive to implement policy choices that increase risk. Our results also indicate that these investment and financial policy choices are among the primary mechanisms through which vega affects stock price volatility.

Growth, Corporate Profitability, and Value Creation

Associating corporate performance and shareholder value creation with growth in earnings (or sales) has been the modus operandi in the investment industry. It has greatly influenced managerial compensation schemes and portfolio decisions. We shed light on the relationship between growth and performance by addressing two broad questions. First, what is the relationship between corporate profitability metrics, such as economic value added, and the company's earnings or sales growth rate? Second, does maximizing corporate profitability necessarily enhance shareholder value (as measured by Jensen's alpha)? Using multivariate analysis, we show that, although the corporate profitability measures generally rise with earnings and sales growth, an optimal point exists beyond which further growth destroys shareholder value and adversely affects profitability.

Growth, Corporate Profitability, and Shareholder Value Creation

Associating corporate performance and shareholder value creation to growth in earnings (or sales) has been the modus operandi in the investment industry, greatly influencing managerial compensation schemes and portfolio decisions. This paper sheds light on the relationship between growth and performance by addressing two broad questions. First, what is the relationship between corporate profitability metrics, such as EVA, ROE, or ROI, and the firm's earnings (sales) growth rate? Second, does maximizing corporate profitability necessarily enhance shareholder value (as measured by Jensen's alpha)? Using multivariate analysis, we show that while these measures generally rise with earnings and sales growth, there exists an optimal point beyond which further growth destroys shareholder value and adversely impacts profitability. Moreover, the analysis shows that firms with moderate growth in earnings (sales) show the highest rates of return and value creation for their owners, supporting Fuller and Jensen (2002) warnings about the dangers of conforming to market pressures for growth.

Empire building by corporate managers:

The paper reports two findings. First, independent corporate managers operating under a linear incentive contract tend to overinvest, thus failing to maximize the wealth of corporate owners. This provides a formal proof of Jensen's influential proposal that under separation of ownership and control investment will be inefficient. Second, the empire-building motive is shown to be related to the degree of uncertainty, the structure of the managerial compensation scheme, and the degree of risk aversion and preference for prudence. The model provides an integration of the traditional neoclassical theory of investment under uncertainty and the theory of investment under separation of ownership and control introduced by the theory of corporate finance.

Managerial Incentives Based on Acquisition of Information

In a moral hazard setting, we model the fact that the agent may get private signals about the final outcome of his effort before the public realization of this outcome. Actions affect both the distribution of the outcome and the quality of the agent's private information. We compare simple contracts, based on output only, with revelation contracts, based on output and messages about signals. Revelation contracts give the agent some discretionary power during the course of the relationship; they are optimal if and only if lowering effort does not increase the quality of private information in the sense of Blackwell (1953). In the context of managerial compensation schemes, the revelation contracts we analyze can be viewed as allowing the agent to exercise an option on the final profits before the realization of these profits. The theory thus provides an alternative justification of the widespread use of stock options in managerial compensation schemes, as opposed to compensation schemes that rely only on salary, bonus, and (restricted) stock plans.

Internal rationing and agency problems in decentralized capital budgeting

This article is a study of the institutional aspects of capital budgeting. It is shown that the process of decentralized capital budgeting suffers from several agency problems, such as over-optimistic forecasts, adverse selection, adverse incentives, recurring needs, myopic bias, measuring problems and mobility for managers. Internal rationing at the divisional level is found to be an effective complement to managerial compensation schemes in solving these agency problems.