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What Death Can Tell: Are Executives Paid for Their Contributions to Firm Value?
Bang Dang Nguyen & Kasper Meisner Nielsen
Management Science, forthcoming
Abstract:
Using stock price reactions to sudden deaths of top executives as a measure of expected contribution to shareholder value, we examine the relationship between executive pay and managerial contribution to shareholder value. We find, first, that the managerial labor market is characterized by positive sorting: managers with high perceived contributions to shareholder value obtain higher pay. The executive pay-contribution relationship is stronger for professional executives and for executives with high compensation. We estimate, second, that an average top executive (chief executive officer) appears to retain 71% (65%) of the marginal rent from the firm-manager relationship. We examine, third, how the executive pay-contribution relationship varies with individual, firm, and industry characteristics. Overall, our results are informative for the ongoing discussion about the level of executive compensation.
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Making the Numbers? 'Short Termism' & the Puzzle of Only Occasional Disaster
Hazhir Rahmandad, Nelson Repenning & Rebecca Henderson
Harvard Working Paper, October 2014
Abstract:
Much recent work in strategy and popular discussion suggests that an excessive focus on "managing the numbers" ― delivering quarterly earnings at the expense of longer term investments ― makes it difficult for firms to make the investments necessary to build competitive advantage. "Short termism" has been blamed for everything from the decline of the US automobile industry to the low penetration of techniques such as TQM and continuous improvement. Yet a vigorous tradition in the accounting literature establishes that firms routinely sacrifice long-term investment to manage earnings and are rewarded for doing so. This paper presents a model that reconciles these apparently contradictory perspectives. We show that if the source of long-term advantage is modeled as a stock of capability that accumulates over time, a firm’s proclivity to manage short-term earnings at the expense of long-term investment can have very different consequences depending on whether the firm's capability is close to a critical "tipping threshold". When the firm operates above this threshold, managing earnings smoothes revenue and cash flow with few long-term consequences. Below it, managing earnings can tip the firm into a vicious cycle of accelerating decline. Our results have important implications for understanding managerial incentives and the internal processes that create sustained advantage.
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Impression Management and the Biasing of Executive Pay Benchmarks: A Dynamic Analysis
Mathijs De Vaan & Thomas DiPrete
Columbia University Working Paper, October 2014
Abstract:
We study the selection of peers into compensation peer groups reported by U.S. corporations. Securities and Exchange Commission (SEC) regulation requires firms to report these peer groups which are used by investors and shareholders to benchmark the compensation of CEOs. Building on a novel, dynamic analysis of more than 1,400 compensation peer groups since 2006, this paper presents new evidence that compensation peer groups are biased upwards relative to neutrally chosen “natural” peer groups. This upward bias is masked by several factors including normative selection on other criteria than compensation and the strong negative relationship between bias and the percentile at the named peer group at which the CEO is compensated. We find that adjustments to compensation peer groups are often better explained as bias-maintaining impression management than as structural adjustments to align peer groups more closely with the normative principles for peer group selection. We also find that peer group bias cannot generally be explained away as a reward for CEO talent. Our research suggests that although the SEC regulation was intended to minimize rent extraction, it has given firms a tool to manage impressions of shareholders and justify excessive pay.
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Dark Side of CEO Ability: CEO General Managerial Skills and Cost of Equity Capital
Dev Mishra
Journal of Corporate Finance, December 2014, Pages 390–409
Abstract:
CEOs with substantial general managerial ability (generalist CEOs) possess a substantial share of organization (human) capital and have different risk-taking incentives than do their counterpart specialist CEOs. Using an index increasing in CEO general managerial skills as a proxy for general managerial ability, we find that investors require higher returns from firms featuring CEOs who have profuse general managerial ability. Furthermore, expected returns are significantly increasing with CEO general managerial ability in firms with high organization capital, that belong to M&A-intensive industries and that have complex operations, high agency problems and high anti-takeover provisions. These findings are consistent with arguments that organization (human) capital has significant expected return implications and that CEOs with higher general managerial skills may lead to higher agency problems, feature different risk-taking incentives and be more costly to retain in times of need.
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Yesterday's Heroes: Compensation and Risk at Financial Firms
Ing-Haw Cheng, Harrison Hong & José Scheinkman
Journal of Finance, forthcoming
Abstract:
Many believe that compensation, misaligned from shareholders’ value due to managerial entrenchment, caused financial firms to take creative risks before the financial crisis of 2008. We argue that even in a classical principal-agent setting without entrenchment and with exogenous firm risk, riskier firms may offer higher total pay as compensation for the extra risk in equity stakes born by risk-averse managers. Using long lags of stock price risk to capture exogenous firm risk, we confirm our conjecture and show that riskier firms are also more productive and more likely to be held by institutional investors, who are most able to influence compensation.
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Corporate Social Responsibility or CEO Narcissism? CSR Motivations and Organizational Performance
Oleg Petrenko et al.
Strategic Management Journal, forthcoming
Abstract:
This study builds on insights from both upper echelons and agency perspectives to examine the effects on corporate social responsibility (CSR) practices of CEO’s narcissism. Drawing on prior theory about CEO narcissism, we argue that CSR can be a response to leaders’ personal needs for attention and image reinforcement and hypothesize that CEO narcissism has positive effects on levels and profile of organizational CSR; additionally, CEO narcissism will reduce the effect of CSR on performance. We find support for our ideas with a sample of Fortune 500 CEOs, operationalizing CEO narcissism with a novel media-based measurement technique that uses third-party ratings of CEO characteristics with validated psychometric scales.
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Investment Banks as Corporate Monitors in the Early 20th Century United States
Eric Hilt & Carola Frydman
NBER Working Paper, October 2014
Abstract:
We use the Clayton Antitrust Act of 1914 to study the effect of bankers on corporate boards in facilitating access to external finance. In the early twentieth century, securities underwriters commonly held directorships with American corporations; this was especially true for railroads, which were the largest enterprises of the era. Section 10 of the Clayton Act prohibited investment bankers from serving on the boards of railroads for which they underwrote securities. Following the implementation of Section 10 in 1921, we find that railroads that had maintained strong affiliations with their underwriters saw declines in their valuations, investment rates and leverage ratios, and increases in their costs of external funds. We perform falsification tests using data for industrial corporations, which were not subject to the prohibitions of Section 10, and find no differential effect of relationships with underwriters on these firms following 1921. Our results are consistent with the predictions of a simple model of underwriters on corporate boards acting as delegated monitors. Our findings also highlight the potential risks of unintended consequences from financial regulations.
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Do Compensation Consultants Enable Higher CEO Pay? New Evidence from Recent Disclosure Rule Changes
Jenny Chu, Jonathan Faasse & Raghavendra Rau
University of Cambridge Working Paper, September 2014
Abstract:
In July 2009, the SEC announced additional disclosure rules requiring firms that purchase other services from their compensation consultants to disclose fees paid for both compensation consulting and other services. This exogenous requirement dramatically increased both the turnover of compensation consultants and the number of specialist firms in the industry solely providing executive compensation consulting services. After the rule change, client firms that switched to specialist consultants paid their chief executive officers (CEOs) 9.7% more in median total compensation than a matched sample of firms that remained with multi-service consultants. Compensation consultants retained solely by the board are associated with 12.9% lower median pay levels than a propensity-score matched sample of firms with additional management-retained consultants. Finally, CEOs at firms that start hiring compensation consultants experience a 7.5% increase in median pay relative to a propensity-score matched sample. Overall, our study finds strong empirical evidence for the hiring of compensation consultants as a justification device for higher executive pay.
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Yinghua Li & Liandong Zhang
Journal of Accounting Research, forthcoming
Abstract:
Using a natural experiment (Regulation SHO), we show that short selling pressure and consequent stock price behavior have a causal effect on managers’ voluntary disclosure choices. Specifically, we find that managers respond to a positive exogenous shock to short selling pressure and price sensitivity to bad news by reducing the precision of bad news forecasts. This finding on management forecasts appears to be generalizable to other corporate disclosures. In particular, we find that, in response to increased short selling pressure, managers also reduce the readability (or increase the fuzziness) of bad news annual reports. Overall, our results suggest that maintaining the current level of stock prices is an important consideration in managers’ strategic disclosure decisions.
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You don't forget your roots: The influence of CEO social class background on strategic risk taking
Jennifer Kish-Gephart & Joanna Tochman Campbell
Academy of Management Journal, forthcoming
Abstract:
Social class is increasingly recognized as a powerful force in people's lives. Yet, despite the long and extensive stream of research on the upper echelons of organizations, we know little about how executives' formative childhood experiences with social class influence strategic choices. In this study, we investigate the influence of CEO social class origins on firm risk taking. We also explore the moderating influences of other important career experiences, including elite education and diverse functional background. Our theory and findings highlight that one's social class origins have a lasting and varying impact on individual preferences, affecting executives' tendency to take risks. By examining this novel managerial characteristic, we offer important implications for social class and upper echelons theorizing.
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'I Do': Does Marital Status Affect How Much CEOs 'Do'?
Gina Nicolosi & Adam Yore
Financial Review, forthcoming
Abstract:
This paper explores whether a CEO's marital status reveals unobservable risk preferences which influence their firm’s investment and compensation policies. Using biographical data for CEOs of large domestic companies, we find that corporate deal-making activity (e.g., mergers, joint ventures, major capital expenditures, etc.) and overall firm riskiness both increase significantly with personal life restructuring (e.g., marriages and divorces). This relation is supported by an instrumental variables analysis and also an investigation surrounding CEO turnover. Finally, the link between a CEO’s marital status and preference for option-based compensation further suggests that personal restructuring may be an indicator of executive risk appetites.
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CEO Narcissism and the Impact of Prior Board Experience on Corporate Strategy
David Zhu & Guoli Chen
Administrative Science Quarterly, forthcoming
Abstract:
We examine how chief executive officer (CEO) narcissism influences the interorganizational imitation of corporate strategy. We theorize that narcissistic CEOs are influenced more by the corporate strategies they experienced on other boards and less by the corporate strategies experienced by other directors. These effects are strengthened if the other firms to which the CEO has interlock ties have high status and if the CEO is powerful. Through longitudinal analyses of Fortune 500 companies’ decisions (from 1997 to 2006) related to the acquisition emphasis of a firm’s growth strategy and the firm’s level of international diversification, we show that narcissistic CEOs are influenced by corporate strategies that they witnessed at other firms much more than other CEOs. In addition, relatively narcissistic CEOs not only strongly resist the influence of other directors’ prior experience but also tend to demonstrate their superiority by adopting corporate strategies that are the opposite of what fellow directors’ prior experience would suggest. Our theory and results highlight how CEO narcissism limits directors’ influence over corporate strategy and influences CEOs’ learning and information processing in making strategic decisions.
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The Impact of Prior Stock Market Reactions On Risk Taking in Acquisitions
Shyam Kumar, Jaya Dixit & Bill Francis
Strategic Management Journal, forthcoming
Abstract:
We study the relationship between the stock market's reaction to a prior acquisition and the risk associated with a subsequent acquisition. Using a sample of 823 acquisitions over the period 1990–2006 we find that acquirers buy increasingly volatile targets both as the abnormal dollar gains from the previous acquisition announcement increase, and as the abnormal dollar losses increase (i.e. a V shaped relationship). Our findings are consistent with psychological theories of decision making, including prospect theory and the house money effect. In addition, they highlight that the stock market reaction to the prior acquisition announcement acts as an important reference point in acquisition decisions.
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Are the Benefits of Debt Declining? The Decreasing Propensity of Firms to be Adequately Levered
Ranjan D’Mello & Mark Gruskin
Journal of Corporate Finance, December 2014, Pages 327–350
Abstract:
We observe a persistent increase in the percentage of firms with little or no debt in their capital structure over the last three decades. The fraction of firms with less than five percent debt in their capital structure increases from 14.01 percent in 1977 to 34.42 percent in 2010 while the percentage of all-equity firms increases 200 percent over the same period. We find that even after controlling for firm- and industry-specific variables that are relevant to capital structure policy, there is a deficiency in firms’ propensity to be levered. Additionally, the deficiency is increasing over time and by 2010 the percent of firms that are nearly all-equity is twice the predicted level. Our findings are robust to different methodologies, specifications, and time periods. Overall, these results suggest that the well-documented benefits of leverage are less valuable over the sample period and that the determinants of firms’ capital structure decisions have evolved since the 1970s.
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Does Uncertainty about Management Affect Firms' Costs of Borrowing?
Yihui Pan, Tracy Yue Wang & Michael Weisbach
NBER Working Paper, November 2014
Abstract:
Uncertainty about management appears to affect firms’ cost of borrowing and financial policies. In a sample of S&P 1500 firms between 1987 and 2010, CDS spreads, loan spreads and bond yield spreads all decline over the first three years of CEO tenure, holding other macroeconomic, firm, and security level factors constant. This decline occurs regardless of the reason for the prior CEO’s departure. Similar but smaller declines occur following turnovers of CFOs. The spreads are more sensitive to CEO tenure when the prior uncertainty about the CEO’s ability is likely to be higher: when he is not an heir apparent, is an outsider, is younger, and when he does not have a prior relationship with the lender. The spread- tenure sensitivity is also higher when the firm has a higher default risk and when the debt claim is riskier. These patterns are consistent with the view that the decline in spreads in a manager’s first three years of tenure reflects the resolution of uncertainty about management. Firms adjust their propensities to issue external debt, precautionary cash holding, and reliance on internal funds in response to these short-term increases in borrowing costs early in their CEOs’ tenure.
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Paying the price? The impact of controversial governance practices on managerial reputation
Michael Bednar, Geoffrey Love & Matthew Kraatz
Academy of Management Journal, forthcoming
Abstract:
This study directly examines the reputational penalties that managers pay when they engage in controversial governance practices that raise questions about managerial self-interest. These penalties should deter questionable behavior and enable reputation to serve a social control function, yet we know little about how and when these penalties are actually imposed. Unlike prior research in this vein, we account for the fact that reputational penalties associated with such practices may differ across audiences because of differences in interpretations of the practice and differences in causal attributions about its use. Specifically, we develop theory to explain how and when stock analysts and peer executives applied reputational penalties to managers when firms used a poison pill. We find that the reputational penalties associated with poison pills differed substantially between these two groups and that these groups applied different penalties depending on the media coverage that the poison pill received, the performance of the firm, and the extent to which the practice had already been adopted. The findings suggest that reputational penalties for questionable behaviors may be more contingent and harder to sustain than previously thought.
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Do analysts matter for governance? Evidence from natural experiments
Tao Chen, Jarrad Harford & Chen Lin
Journal of Financial Economics, forthcoming
Abstract:
Building on two sources of exogenous shocks to analyst coverage (broker closures and mergers), we explore the causal effects of analyst coverage on mitigating managerial expropriation of outside shareholders. We find that as a firm experiences an exogenous decrease in analyst coverage, shareholders value internal cash holdings less, its CEO receives higher excess compensation, its management is more likely to make value-destroying acquisitions, and its managers are more likely to engage in earnings management activities. Importantly, we find that most of these effects are mainly driven by the firms with smaller initial analyst coverage and less product market competition. We further find that after exogenous brokerage exits, a CEO's total and excess compensation become less sensitive to firm performance in firms with low initial analyst coverage. These findings are consistent with the monitoring hypothesis, specifically that financial analysts play an important governance role in scrutinizing management behavior, and the market is pricing an increase in expected agency problems after the loss in analyst coverage.
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Explicit Employment Contracts and CEO Compensation
Wei-Ling Song & Kam-Ming Wan
Journal of Corporate Finance, forthcoming
Abstract:
This study investigates the relation between the use of explicit employment agreements (EA) and CEO compensation. Overall, our findings are broadly consistent with the predictions of Klein, Crawford, and Alchian (1978) that an EA is used to induce CEOs to make firm-specific human capital investments that are vulnerable to opportunistic behavior. We determine that compensation is higher when CEOs have employment agreements that are written, longer in duration, or more explicit in terms. Additionally, such employment agreements are more likely to occur when firms have (i) externally hired CEOs, (ii) CEOs with large abnormal compensation, (iii) low investment intensity, (iv) low growth opportunities, and (v) CEOs with a short employment history with the firm.