Pay-performance Sensitivity Research Articles

Effects of minimum wage policies on executive compensation contracts: An empirical analysis in China

This paper investigates the impact of minimum wage policies on executive pay-for-performance sensitivity (PPS) in the compensation packages of A-share listed firms in China. Using data from 745 counties between 2007 and 2020, we find that minimum wage policies lead to a decrease in PPS. This finding remains robust through instrumental variable approaches, cross-border matching tests, alternative measurements, and other rigorous tests. Moreover, the negative impact of minimum wage on PPS is more pronounced in companies with higher labor dependency, limited ability to pass on labor costs to customers, and lower risk resilience. These results support the hypothesis that rising labor costs due to increased minimum wage, which lead to performance distortion and heightened risk, promote shareholders to reduce PPS to optimize compensation contracts for value maximization.

Impact of internal governance on investment policy: Evidence from CEO voluntary turnovers

The theoretical and empirical literature suggests that CEO might not make risky long-term investments if the CEO believes that the benefit of such investments would not materialize or is not recognized by the market until after the CEO has retired. This paper tests the predictions of the Acharya, Myers, and Rajan (2011) internal governance model to counteract the CEO’s tendency to forego such investments on a sample of voluntary CEO turnovers. We find that the optimal level of sharing of tasks between the CEO and her top-management team, the firm’s internal governance, is dependent on the CEO’s career horizon. Additionally, we find the effect of internal governance only matters for older CEOs. We also find that the closer the internal governance is to the optimal level, the smaller is the underinvestment for an older outgoing CEO. We find that the new incoming CEO divests profitably the assets acquired under good internal governance. Finally, we find that optimal internal governance is found to have positive effects on corporate innovation. Our results are robust to continuous matching by generalized propensity score and controlling for the CEO’s explicit pay-performance sensitivity, succession plan, and pay duration.

Multiple large shareholders and pay-performance sensitivity: Evidence from China

This study investigates whether and how multiple large shareholders affect pay-performance sensitivity. Our findings suggest that multiple large shareholders can enhance pay-performance sensitivity by improving the efficacy of compensation committees and reducing inefficient investments. Further analysis reveals that this positive governance effect is more pronounced in firms with more severe agency problems, weaker external governance mechanisms, and higher accounting comparability. We also find that the impact of multiple large shareholders on pay-performance sensitivity is more significant in state-owned enterprises, where corporate governance is often deficient due to government’ multifaceted objectives and limited oversight of managers. Overall, this study contributes to existing literature by enriching the research on ownership structure and pay-performance sensitivity, and offering new insights into the governance dynamics associated with multiple large shareholders within the context of compensation contracting.

CEO pay-performance sensitivity and pay for luck and asymmetry

PurposeThis paper studies the relationship between CEO pay-performance sensitivity and CEO pay for luck as well as the asymmetric benchmarking of CEO pay in which good luck is rewarded but bad luck is not penalized symmetrically. We further explore the impact of the regulatory changes on executive compensation taking effect in the 2000s on CEO pay for luck and asymmetry.Design/methodology/approachIn this study, we examine the relationship between CEO pay-performance sensitivity and CEO pay for luck and the asymmetric benchmarking of CEO compensation. The sample consists of DJIA component companies over a 71-year period from 1950 to 2020. CEO pay-performance sensitivity is measured by both delta and Jensen-Murphy pay-performance sensitivity.FindingsWe find that an increase in CEO pay-performance sensitivity as measured by both delta and Jensen-Murphy pay-performance sensitivity leads to an increase in the degree of CEO pay for luck but tends to reduce the level of CEO pay for luck asymmetry. In addition, we find that the major pay-related regulatory changes in recent years have mitigated the degree of CEO pay for luck and pay asymmetry, in which CEO pay structure and the associated CEO pay-performance sensitivity are major mechanisms through which the regulatory changes take effect.Research limitations/implicationsOur findings provide empirical evidence supporting the argument that both optimal contracting and rent extraction should be considered as important determinants of CEO compensation.Practical implicationsWhen a firm designs the pay packages for its CEO to align CEO wealth to firm performance, CEO pay-performance sensitivity is expected to improve. However, the improved CEO PPS can also lead to an increased CEO pay for non-performance (Luck), which is an undesired outcome from the shareholder view. Therefore, a firm should thoroughly consider various advantages and disadvantages when compensating its top executives. Third, pay-related regulations have indeed achieved some intended outcomes such as the diminished pay for luck and asymmetry, but they also exacerbated the positive relationship between CEO pay-performance sensitivity and the asymmetric benchmarking of CEO pay. It seems that executive pay-related regulations cannot achieve perfect outcomes without side effects. Continuous reforms and regulations on corporate governance should be a dynamic process under various changing situations.Originality/valueThis study contributes to the literature on executive pay for luck and asymmetry in several ways. First, our study is among the few studies empirically testing the relationship between CEO pay-performance sensitivity and pay for luck and asymmetry. We find that CEO pay-performance sensitivity tends to increase the degree of CEO pay for luck but reduce the level of asymmetric benchmarking of CEO pay. These findings partly support the rent extraction theory grounded on the managerial power hypothesis and partly support the optimal contracting theory. Our findings confirm that the optimal contracting theory and the rent extraction theory are both important for explaining the practices and historical trends of CEO compensation.

Illuminating the murk: The effect of business complexity on voluntary disclosure

Analyzing the complex financial landscape of multi-segment conglomerates requires a more nuanced approach than that required for single-segment firms. This paper reveals that conglomerates strategically enhance their transparency by voluntarily disclosing more information to compensate for their business complexity. This finding is particularly pronounced when there is an increased demand for information from stakeholders and analysts or when the executive pay-performance sensitivity is higher. By strategically embracing transparency, conglomerates transform the complexities inherent in their financial reporting into a catalyst for higher valuation and lower capital costs. Overall, our study demonstrates that multi-segment firms tactically deploy voluntary disclosure to navigate their intricate business environment effectively.

Does internal control affect firms' use of derivatives? Evidence from China

This study investigates the impact of internal control on firms' use of derivatives. We find that firms with strong internal controls are more likely to use derivatives than firms with weak internal controls. In cross-sectional analyses, we find that this relationship is more pronounced for subsamples with lower executive pay-performance sensitivity, lower executive ownership, smaller board size, and higher proportion of busy directors. Additional analyses suggest that among the five components of internal control, control environment, risk assessment, information & communication, and monitoring exhibit stronger impacts on derivatives use than that of control activities. We contribute to the literature on the determinants of firms' use of derivatives and highlight some components of internal control are more critical than the others in guiding a firm's derivatives usage.

Top Management Team Incentive Dispersion and Managerial Efficiency

AbstractThis study examines the association between dispersion in pay‐performance sensitivities (PPS) among top management team (TMT) members and managerial efficiency. While prior research has focused on managerial efficiency as an innate characteristic of managers, this study explores how managerial incentive dispersion shapes managerial efficiency. Using a sample of US firms from 1993 to 2019, we find a negative relationship between TMT incentive dispersion and managerial efficiency, suggesting that higher levels of incentive dispersion can potentially affect managerial efficiency by reducing coordination and cooperation among TMT members. We employ a range of robustness tests and find consistent and robust results. Overall, this study contributes to the literature on executive compensation by providing novel insights into the implications of incentive dispersion among executives for managerial efficiency.

Reversal of impairment losses and earnings management

Although the impairment test is relevant to the quality of accounting information, it requires subjective estimates that allow discretion to manage companies and give rise to earnings management, especially when losses can be reversed. In this context, this research aimed to investigate whether there is a relationship between the reversals of impairment losses evidenced by Brazilian companies listed on B3 and the practice of earnings management between 2010 and 2019. For this, descriptive and quantitative research was conducted, which tested three hypotheses initially developed in the work of Duh et al. (2009) to analyze whether the companies that most recognize impairment losses reverse these losses in the future to avoid the decrease in accounting earnings and whether this behavior is more pronounced in higher levels of indebtedness or when their managers are paid for performance. The findings revealed that, although companies that recognize more losses conduct more significant reversals in the future, these reversals did not occur in the context of declining earnings and were not significantly influenced by indebtedness and the managers’ pay-performance sensitivity. Considering the scarcity of empirical evidence on this topic in Brazil and the need to observe this phenomenon in different institutional and regulatory environments, it is expected that this study will contribute to stimulating the conducting of other similar studies, as well as to foster discussions on how the possibility of reversing impairment losses affects the quality of accounting information.

O efeito moderador do narcisismo do CEO na sensibilidade da remuneração ao desempenho

ABSTRACT This study aims to examine whether the Chief Executive Officer (CEO) narcissism has a moderating effect on pay-performance sensitivity. We fill a gap in the existing literature, which overlooks the behavioral aspects of agents in the design of executive compensation plans, by providing evidence of the moderating effect of CEO narcissism on pay-performance sensitivity. We shed light on the fact that shareholders and potential investors might face higher agency costs when investing in firms led by narcissistic CEOs, considering that narcissistic CEOs tend to receive higher levels of compensation than their peers, regardless of the company’s performance. This study also has implications for board members and recruiters, who may take this psychological aspect into account when proposing compensation schemes to CEOs. The results extend the prior discussion on low pay-performance sensitivity (or its non-significance) by suggesting that this might be partially attributed to the psychological characteristics of CEOs, which play a role in the design of executive compensation. A sample of 1,057 non-financial U.S. firms (8,869 firm-year observations) during the period 2002-2018 was analyzed using system generalized method of moments (GMM-SYS) regressions due to the endogenous relationship between CEO compensation and firm performance. The main results show that CEO narcissism reduces the association between CEO compensation and firm performance, supporting the prediction that narcissism can be viewed as a “dark side” in the design of executive compensation plans. This finding is robust to alternative measures of pay-performance sensitivity, and further robustness checks indicate that our results are not driven by CEO overconfidence. Therefore, this study contributes to the literature by providing, to the best of our knowledge, the first empirical evidence of the moderating effect of CEO narcissism on pay-performance sensitivity.

ESG disclosure and pay-performance sensitivity

ESG disclosure and pay-performance sensitivity

The moderating effect of CEO narcissism on pay-performance sensitivity

RESUMO O objetivo deste estudo é examinar se o narcisismo do Diretor Executivo (Chief Executive Officer - CEO) tem um efeito moderador sobre a sensibilidade da remuneração ao desempenho (pay-performance sensitivity). Preenchemos uma lacuna na literatura existente, que ignora os aspectos comportamentais dos agentes na elaboração dos planos de remuneração dos executivos, fornecendo evidências do efeito moderador do narcisismo do CEO sobre a sensibilidade da remuneração ao desempenho. Esclarecemos o fato de que os acionistas e os investidores potenciais podem enfrentar custos de agência mais altos ao investir em empresas lideradas por CEOs narcisistas, considerando que os CEOs narcisistas tendem a receber níveis mais altos de remuneração do que seus pares, independentemente do desempenho da empresa. Este estudo também tem implicações para os membros do conselho e recrutadores, que podem levar em conta esse aspecto psicológico ao propor esquemas de remuneração aos CEOs. Os resultados estendem a discussão anterior sobre a baixa sensibilidade da remuneração ao desempenho (ou sua não significância), sugerindo que isso pode ser parcialmente atribuído às características psicológicas dos CEOs, que desempenham um papel na concepção da remuneração dos executivos. Uma amostra de 1.057 empresas não financeiras dos EUA (8.869 observações empresa-ano) durante o período de 2002 a 2018 foi analisada usando regressões do método generalizado de momentos sistêmico (system generalized method of moments - SYS-GMM) devido à relação endógena entre a remuneração do CEO e o desempenho da empresa. Os principais resultados mostram que o narcisismo do CEO reduz a associação entre a remuneração do CEO e o desempenho da empresa, corroborando a previsão de que o narcisismo pode ser visto como um “lado sombrio” na elaboração de planos de remuneração de executivos. Essa constatação é robusta em relação a medidas alternativas de sensibilidade da remuneração ao desempenho, e outros testes de robustez indicam que nossos resultados não são motivados pelo excesso de confiança do CEO. Portanto, este estudo contribui para a literatura ao fornecer, até onde sabemos, as primeiras evidências empíricas do efeito moderador do narcisismo do CEO sobre a sensibilidade da remuneração ao desempenho.

The Effect of Local Internet Development on Employees’ Salary: Evidence from China

ABSTRACT Using empirical data from China, this study examines the impact of local internet development on non-executive employees’ salaries. Research findings show that internet development can increase employees’ salary and pay-performance sensitivity. This effect can be more significant in non-state-owned enterprises (Non-SOEs for short), firms faced with fierce competition, and firms paid little attention to employee protection. Mechanism analysis finds that the positive impact of internet development on increasing total factor productivity and reducing information asymmetry can partly interpret the effect. From the perspective of employees’ salaries, this study sheds light on the impact of technological progress on micro-production relations.

Corporate digital transformation, governance shifts and executive pay-performance sensitivity

We utilized text mining techniques to gauge a company's level of digital transformation and found that the higher the degree of digitalization, the more apparent the decoupling of executive compensation from performance, indicating lower sensitivity of executive pay to performance outcomes. Within the framework of agency theory, digital technology empowers shifts in corporate governance models, enabling process-based behavioral monitoring and constraining governance mechanisms, thereby reducing reliance on outcome-based incentive mechanisms. Heterogeneous analysis reveals that the substitutive effect of digitization on the pay-performance sensitivity is more pronounced in companies with lower executive ownership. These companies often rely more on compensation incentives in the absence of digital technology. Moreover, the effectiveness of digital technology in enhancing governance depends on the user's wealth of knowledge and technical proficiency. We additionally confirmed that digital transformation has a positive impact on mitigating agency problems, as it enhances information quality, improves internal control standards, reduces excessive perk, and diminishes managerial short-termism. In essence, digital transformation indeed elevates governance regime. Furthermore, we discovered that digitalization increases the association between compensation and executive effort. Our research findings provide a fresh perspective on corporate governance and executive incentive mechanisms in emerging markets.

The impact of top management team incentive dispersion on Non-GAAP reporting

We examine whether the dispersion of pay-performance sensitivity (PPS) amongst the top management team (TMT) impacts the likelihood of firms disclosing non-GAAP earnings and the quality of non-GAAP earnings. Management compensation contracts are designed to incentivize executive team members individually and in the aggregate. By structuring these contracts to have similar PPS, those charged with governance can increase collaboration amongst the TMT. However, this collaboration can turn into the TMT colluding to make firm decisions that result in the highest compensation for the TMT. Thus, a greater dispersion of PPS can lead to less collusion. We find that the likelihood of firms reporting non-GAAP earnings decreases and the quality of non-GAAP earnings disclosures increases when there is a higher dispersion of PPS. These findings are consistent with executives that are less incentivized by temporary stock price increases suppressing other executives from eliciting firm scrutiny by disclosing non-GAAP earnings and releasing low-quality non-GAAP earnings. Additionally, we find these effects on non-GAAP earnings are more likely to occur in firms with weaker governance and when the management team has a shorter tenure of working together. Overall, our research provides evidence of the association between the dispersion of TMT PPS and non-GAAP earnings decisions.

Does the age of compensation committee members matter for CEO compensation?

AbstractResearch Question/IssueWe examine the impact of the age of compensation committee (CC) members on CEO compensation. Sociological theory suggests that age is a significant demographic factor influencing behavior. We argue that monitoring intensity increases with age because older directors are more likely to commit to their fiduciary duties.Research Findings/InsightsUsing FTSE 350 firms for the period 2002 to 2017, we find that CC members' age is negatively associated with the level of CEO pay but positively associated with pay–performance sensitivity after controlling for risk aversion attitude, experience in board monitoring, knowledge of the firm, and other firm and CEO characteristics. The relationships remain robust to alternative measures for age and compensation, using two‐stage least squares and high‐dimensional fixed effects models. Consistent with the view that older individuals tend to hold higher ethical standards and concomitant closer monitoring, we find that age effects are sensitive to the influence of ethical factors and are strongest for those firms for which intense monitoring is most needed. This suggests that age operates via older directors carrying out their roles more assiduously. We further show that our findings are less likely to be driven by director reputational effects, and the relationship between CC member age and CEO compensation persists even when we control for multiple dimensions of culturally inherited attributes of the CC members.Theoretical/Academic ImplicationsDespite the large literature on the influence of demographic characteristics on corporate governance, this study is the first on the monitoring effect of CC members' age. It contributes to the literature on the influence of demographic characteristic. It also contributes to the literature on CEO compensation by identifying a demographic factor—age—as a determinant of CEO pay, after controlling for the economic and corporate governance variables of the firm.Practitioner/Policy ImplicationsThis study highlights the role of demographic factors in explaining the monitoring of the CEO compensation contracting process and provides timely evidence on the recent regulatory changes.

Top management team incentive dispersion and audit fees

AbstractWe study whether heterogeneity in pay‐performance sensitivities (PPS) across top management team (TMT) members influences audit fees. Evidence from current literature reveals that the heterogeneity in PPS among TMT affects TMT managers’ motivation to coordinate their activities to manipulate earnings. Since the quality of earnings lowers auditors’ financial reporting risk, we posit that audit fees will be lower when dispersion in the PPS among TMT is high. We demonstrate that audit fees are negatively linked with dispersion in PPS among TMT members. This finding is robust to numerous sensitivity testing. Overall, our findings suggest that firms benefit from the heterogeneity in PPS among TMT members in the form of lower audit fees.

CEO Pay-performance Sensitivities in the ESG Managed Firms

CEOs of highly rated ESG firms are paid significantly higher salaries. High ESG firms are larger, more profitable, and mature firms, facing less risks compared to low ESG rated firms. Although these systematic differences in firm characteristics account for a significant portion of the CEO pays, when we decompose the CEO pays between different ESG groups, there exists a non-trivial residual portion of the unexplained compensation gap that the traditional firm characteristics can not fully explain. About 79.8% of the mean difference is attributable to the firm characteristic part and the residual 20.2% can be ascribed to the ESG group effect. The high ESG firms are more active in using the incentive compensation scheme to discipline managers while the low ESG firms are more conservative in adopting the sensitive incentive pay systems because they are more susceptible to the negative factors such as risk and leverage. As a result, we observe significantly higher pay-performance sensitivities for the high ESG group and the low ESG firms are paid lower than what their firm characteristics prescribe. The ESG rating has an orthogonal part of the explanatory power that contributes to the pay-performance sensitivity over the traditional solvency measure such as credit ratings.

Export diversification, CEO compensation and CEO pay-performance sensitivity: lesson from china

Export diversification, CEO compensation and CEO pay-performance sensitivity: lesson from china

CEO prior uncertainty and pay–performance sensitivity

AbstractA CEO's pay–performance sensitivity (PPS) is higher in the first year of their tenure than in the following years. I explain this finding with reference to chief executive officer (CEO) prior uncertainty: Because of information asymmetry and/or uncertainty about the quality of the match between a CEO and a firm, first‐year compensation is often arranged to depend largely on performance. Consistent with this explanation, CEOs with higher prior uncertainty exhibit higher first‐year PPS. Also, PPS is higher for outsider CEOs than insider CEOs. Among outsider CEOs, first‐year PPS is lower for former executives of large public firms. An insider CEO's service time in a firm before becoming the CEO reduces first‐year PPS.

Revitalizing Organizational Efficiency: Unpacking the Relationship between CEO Turnover, Research and Development, and Pay-Performance Sensitivities in the Financial Sector of Pakistan

This study examines the relationship between senior management turnover, wage structures, and organizational efficiency in the banking industry in Pakistan. Using secondary panel data from annual reports of commercial banks and multiple regression techniques, the study finds that pay-performance sensitivity, R&D investment, and firm age positively impact organizational efficiency. At the same time, higher expense ratios are negatively associated with efficiency. CEO turnover, duality, and board size have a relatively low impact on efficiency. This study provides valuable insights for managers and policymakers in the banking sector, highlighting key areas that should be prioritized to improve efficiency, reduce costs, and increase financial performance. By offering a roadmap for decision-makers to focus their efforts, this study provides a valuable framework for achieving tremendous success in the banking industry.