Transient Institutional Ownership and the Contracting Use of Returns and Earnings

SSRN Electronic Journal 02/2005; DOI: 10.2139/ssrn.663943

ABSTRACT Prior work suggests that, on average, institutional ownership is associated with increased pay-for-performance sensitivity of CEO compensation. However, other studies find that transient institutional ownership is positively associated with myopic managerial actions (Bushee 1998), stock price volatility, and stock mispricing (Bushee 2001). Consequently, the type of institutional ownership may affect the performance measure properties and undermine their usefulness for CEO contracting purposes. In this paper, we posit that transient institutional ownership is negatively associated with the congruence and noise properties of both returns and earnings and, hence, the use of these measures for incentive compensation. Consistent with this conjecture, we find that transient institutional ownership is negatively associated with the sensitivity of CEO cash compensation to both of these measures. Our findings indicate that given a 10% increase in return on equity, the cash compensation of a CEO of a firm with low transient ownership will increase by approximately 3%, while that of a firm with high transient ownership will only increase by approximately 1%.

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