Article

Performance for Pay? The Relation Between CEO Incentive Compensation and Future Stock Price Performance

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Abstract

We find evidence that CEO pay is negatively related to future stock returns for periods up to three years after sorting on pay. For example, firms that pay their CEOs in the top ten percent of excess pay earn negative abnormal returns over the next three years of approximately -8%. The effect is stronger for CEOs who receive higher incentive pay relative to their peers. Our results appear to be driven by high-pay induced CEO overconfidence that leads to shareholder wealth losses from activities such as overinvestment and value-destroying mergers and acquisitions.

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... However, it should be noted that most of the above studies defined firm performance in accounting measures but not the appreciation of firms' stock value. The relationship between future stock returns and executive pay is studied by several papers (e.g., Cooper, Gulen, & Rau, 2009;Lewellen, Loderer, Martin, & Blum, 1992;Malmendier & Tate, 2009;Masson, 1971;McConaughy & Mishra, 1996) while most of them found a positive relationship between executive pay and future stock returns. Cooper et al. (2009) documented that both total and cash compensation is unrelated or insignificantly related to stock returns 1 . ...
... The relationship between future stock returns and executive pay is studied by several papers (e.g., Cooper, Gulen, & Rau, 2009;Lewellen, Loderer, Martin, & Blum, 1992;Malmendier & Tate, 2009;Masson, 1971;McConaughy & Mishra, 1996) while most of them found a positive relationship between executive pay and future stock returns. Cooper et al. (2009) documented that both total and cash compensation is unrelated or insignificantly related to stock returns 1 . Further, they identified that increased executive pay related information will not be quickly incorporated to stock returns due to several reasons. ...
... One such study is by Nikbakht, Shahrokhi, and Martin (2007) where they discovered that if an executive remains in the firm in post IPO period that stock is undervalued and the firm's prospects are bright in the future. Further, Cooper et al. (2009) found an effective trading strategy which yielded positive returns by selling the highest executive compensation firms and buying the lowest executive compensation payers. ...
... Thus enhancing the current CEO remuneration contracts transparency in the Tunisian context would contribute importantly in reestablishing confidence and in insuring investors. Consistent with some previous studies, ( Leonard (1990) [49] ; Attaway (2000) [2] ; Farmer et al. (2013) [26] ; Balafas and Florackis (2014) [6] ; Cooper et al. (2014) [15] ; Ozkan (2011) [62] ; and Mohammed and Phil (2013)) [57] , we did not record a significant relationship between executive compensation and firm economic performance. This inconclusive finding may be due to the mixed effect of executive compensation on firm returns. ...
... Thus enhancing the current CEO remuneration contracts transparency in the Tunisian context would contribute importantly in reestablishing confidence and in insuring investors. Consistent with some previous studies, ( Leonard (1990) [49] ; Attaway (2000) [2] ; Farmer et al. (2013) [26] ; Balafas and Florackis (2014) [6] ; Cooper et al. (2014) [15] ; Ozkan (2011) [62] ; and Mohammed and Phil (2013)) [57] , we did not record a significant relationship between executive compensation and firm economic performance. This inconclusive finding may be due to the mixed effect of executive compensation on firm returns. ...
... This can be argued by the fact that an increase of executive compensation beyond the sector average seems to empirically increase the firm expenses, rather than enhance executives to improve their services. Although these findings are consistent with some existing literature ( (Balafas and Florackis (2014) [6] ; Cooper et al. (2014) [15] ; Ozkan (2011) [62] ; and Mohammed and Phil (2013)) [57] , we expect that these findings may be just immediate results, which are valid only in the short term, and the positive effect of an incentive pay could be felt in the long run. This issue could be a potential subject matter of our future ~ 56 ~ research. ...
Article
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This paper examines the impact of CEO compensation on both firm profitability and risk-taking, from a sample of 61 Tunisian non-financial listed companies, during the period 2010-2018. For robustness, we have used three different firm profitability measures; which are the ROA, the ROE, and Tobin's Q. Besides, we have investigated the impact of executive compensation on the firm returns volatility. Moreover, we have controlled for the sector interaction to obtain more pertinent results. Consistent with the agency theory, evidence suggests that an increase in CEO remuneration would improve the firm return on equity, but affects the firm Tobin's Q and increases the firm's risk-taking. Moreover, findings suggest that when we control for the sector, an increase in CEO remuneration would improve the firm ROE, but amends the firm ROA, Tobin's Q, and the risk-taking level. Finding would be useful for the listed Tunisian companies to develop thinking about the most effective governance practices able to ensure a more transparent executive compensation policy, reassure investors, and improve the firm stock-market value.
... They argued that the success of a corporation does not relate to the level or degree of equity in executive pay but positively related to the extent of hierarchical structure, which is used as a basis for sorting individual human capital endowment and performance. Cooper, Gulen, and Rau (2010) argued that stock options and other forms of long-term compensation had not received much attention. The lack of attention is due to the implicit assumption that in an efficient market, investors immediately capitalise the present value of future firm performance improvement into the stock price when incentive pay of the firm becomes public information. ...
... A significant study, which was based on a panel data from the New York Stock Exchange (NYSE), American Express (AMEX) and National Association of Securities Dealers Automated Quotations (NASDAQ) database from 1994-2006, was conducted by Cooper et al. (2010) that analysed the link between CEO compensation and stock market performance. The study revealed that CEO compensation is negatively related to future shareholder wealth, and that the effect is stronger for CEOs who receive higher incentive pay relative to their peers. ...
... While most of these studies fail to capture the existence of reverse causality, we argue that the presence of reverse causality on the relationship between CEO compensation and financial performance cannot be over-emphasised even if they are controlled in the studies. We, therefore, argued differently from the one-sided argument that (e.g., Cooper et al., 2010;Mehran, 1995;Nyberg et al., 2010) it is the CEO remuneration that influences financial performance by also showing in Table 5 that financial performance also has a more substantial influence on CEO remuneration. Whereas Table 5 confirms the study's Hypothesis 3, it is also in line with the tournament theory, an extension of the agency theory. ...
Article
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Purpose: This article investigates the relationship between executive compensation and financial performance for Alternative Investment Market (AIM)-listed firms in the UK. While most studies have looked at the impact of executive compensation on financial performance, this study argues that the issue of reverse causality cannot be ignored even if it is controlled and therefore investigates the extent to which financial performance can also impact on executive remuneration. Design/methodology/approach: The study relies on a sample of 201 AIM-listed firms in the UK from 2011 to 2016 to examine the relationship between executive compensation and financial performance. It draws on agency and tournament theories to model the relationships between executive compensation and financial performance using various panel regression models. Findings: The findings from the study revealed that the chief executive officer (CEO) remuneration impact on both accounting- and market-based measures of financial performance. It also showed that while performance-based incentives like bonus and other long-term incentives linked to performance significantly impact on financial performance, salary, a cash-based non-performance-related compensation rather negatively affects performance. It was also discovered that financial performance can also influence the level of executive compensation and not always vice versa. Value/originality: The study adds novelties to the existing literature by introducing tournament theory to the studies on the relationship between executive compensation and financial performance. Most of the existing studies have been one sided and emphasise only on the influence of executive remuneration on financial performance. However, based on the tournament theory, the study argued that the issue of reverse causality between the two should not be overemphasised even if it is controlled.
... A common feature of much of the literature is that it views CEO compensation as reward for the realized firm performance and examines the relationship of CEO compensation with current and past performance. However, the other view is that board may reward executives for value-maximizing activities with outcomes that have not yet realized, and hence that are unobservable to outside shareholders (see, Balafas & Florackis, 2014;Cooper, Gulen, & Rau, 2013;Hayes & Schaefer, 2000). Absence of such rewards against unobserved firm performance may indicate unsolved agency problems not captured by corporate governance measures. ...
... Under agency theory, if boards compensate CEOs in Pakistan for both observable and unobservable performance measures and unobservable performance measures correlate with future observable performance measures then current compensation that is unexplained by current observable performance measures is likely to correlate with future observable performance measures (see, Balafas & Florackis, 2014;Carter, Li, Marcus, & HassanTehranian, 2016;Cooper et al., 2013;Hayes & Schaefer, 2000). This leads to the deduction that current CEO compensation can predict future performance, leading to the hypothesis that: ...
... Cash compensation is the remuneration paid to the executives during the fiscal year. It may include base salary and cash bonuses (see, e.g., Cooper et al., 2013;Core, Holthausen, & Larcker, 1999;Ozkan, 2011) or may include base salary, cash bonuses and other cash benefits (see, e.g., Balafas & Florackis, 2014;Conyon & He, 2012;Ntim, Lindop, Osei, & Thomas, 2013). Other forms are included in non-cash compensation. ...
Article
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The study examines whether higher CEO compensation is related to unobserved future firm performance in an emerging market, Pakistan. Further, it extends its scope to analyzing the impact of group affiliation and ownership concentration on the relationship between CEO compensation and future firm performance. The study uses an unbalanced panel data consisting of 1508 firm-year observations from 225 non-financial listed companies in Pakistan Stock Exchange (PSX) for period 2005 to 2012. The multiple regression models adjusted to heteroskedasticity and autocorrelation in error terms are used. The study finds that, in general, CEO compensation is positively associated with future operating performance. However, higher CEO compensation leads to lower operating performance in firms that have lower ownership concentration and are affiliated with business groups. When firms are not affiliated with any group and have high ownership concentration, the relationship between excessive CEO compensation and future operating performance becomes insignificant. Given that efficient compensation packages may lead to long term value creation to shareholders and reduce agency problems, this study highlights an important moderating role of ownership concentration and group affiliation of the firms in emerging markets.
... In line with our theoretical approach, we measure CEO excess pay by comparing it to that of relevant peer firms. Hence, we calculate excess compensation as the deviation of the total compensation of a firm's CEO in a given year from the median of the compensation of CEOs in the ten largest firms in the same industry (e.g., Balafas and Florackis 2014;Cooper et al. 2016). This approach reflects findings by Murphy (1999) and Bizjak et al. (2011) suggesting that firms generally name other firms from the same industry as part of the compensation peer group that they are mandated to report in their proxy statements. ...
... However, it might be an interesting avenue for future research to explore in greater depth the effects that other compensation elements have on corporate reputation-for instance, bonuses or non-monetary benefits. Additionally, our study follows prior research in its basis on a particular understanding of excess compensation (Balafas and Florackis 2014;Cooper et al. 2016). Although we show that our results are robust to other operationalizations of excess compensation, we do not explicitly focus on the implications that arise from differences in stakeholders' understanding of excess compensation. ...
... 1 Scholars have operationalized excess compensation in different ways, either by comparing a focal CEO's compensation level to industry and size-adjusted averages (e.g., Balafas and Florackis 2014), to the peer groups named by the firms in their annual reports (e.g., Bizjak et al. 2011; Yang 2010, 2013;Porac et al. 1999), or to different calculated levels of expected CEO pay based on firm performance, board, CEO and other organizational characteristics (e.g., Brick et al. 2006;Ezzamel and Watson 1998;Fong et al. 2010;Vergne et al. 2018;Wade et al. 2006a). In our study, we follow an understanding of CEO excess compensation as compensation that is above the median of industry peers (Balafas and Florackis 2014;Cooper et al. 2016). ...
Article
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This paper investigates the impact of CEO excess compensation on corporate reputation. Past research has focused mainly on understanding how CEO overpayment is related to firm performance. As a consequence, we know relatively little about the implications of paying excess compensation for other important firm outcomes such as corporate reputation. By analyzing a sample of S&P 100 firms over the period 1995–2010, we show that overpayment in total compensation has a weak positive effect on a firm’s reputation while overpayment in stock options has a significant and negative impact on corporate reputation. Moreover, we find that the negative impact of CEO excess compensation in stock options is augmented if there has been a CEO change during the previous year, whereas this effect is lessened by CEO tenure. These results demonstrate that the relationship between excessive CEO compensation and corporate reputation is complex. It is influenced by the type of compensation and by specific CEO characteristics that invite greater public attention and scrutiny.
... Apparently not. Company success accounts for only 1-7% of the exceptional compensation they receive (Cooper, Gulen, and Rau, 2016;Mullaney, 2015;Sigler, 2011). Some 93-99% of the reason CEOs are paid so much is not due to their positive effect on company performance. ...
... A study by Cooper, Gulen, and Rau (2016) further reinforces the smallness of the relationship between CEO pay and a firm's financial performance. They found that the firm's performance accounted for only 7.2% of the total variance in CEO compensation (2016, see Table 1, p. 36). ...
... "We pay high to get the best. " Cooper, Gulen, and Rau (2016) investigated the relationship between CEO pay and a company's performance going forward. They found that CEOs' compensation above normative levels is negatively related to the future financial returns of the firms they lead. ...
Book
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The issue with Capitalism is more than economics. It is about the survival of humankind. This first-ever book to evaluate the effects of Capitalism from economic, societal, and evolutionary perspectives offers a detailed presentation of an alternative approach to commerce that is founded on the principles of individual freedom and property rights, yet it ensures that all commercial endeavors protect, nurture, and enrich human life and the ecosystem that supports all life. Capitalism, as a theoretical model of an imaginary world, is fine. Empirical evidence makes clear, however, that, as a practical economic system, Capitalism is a sham. Its dominance has undermined our understanding of ourselves as a species; commerce as our common means for enabling each other’s survival, growth, and fulfillment; and our notion of what constitutes appropriate conduct within a society and across societies internationally. It falsely pits individual emergence against social well-being when in fact each requires the other for its realization. This book documents the bases for Capitalism’s destructiveness including its false understanding of human nature and incorrect assumptions about the commercial context. It assumes that all people act egoistically without regard for others, and they do not. It also assumes that no asymmetries of information or power exist between buyers and sellers, and they do. Its theorems, drawn from these errors, construct a system that enables the few to exploit the many. As to human nature, studies repeated hundreds of times have shown that humankind displays two different response dispositions toward others. One portion always acts egoistically as Capitalism posits. Another portion is natively cooperative and other-regarding. For this latter segment, following Capitalism’s guidance requires them to behave in ways that contravene their native inclinations. And, it is the native human dispositions of this second segment of humankind that evolutionary science credits with enhancing our species’ ability to survive and evolve. The research reviewed in this book also clarifies the true nature of commerce; the breadth of human necessities, beyond material needs, that commerce must serve; Capitalism’s real utility as a “social control system”; and the potential consequences for evolved humankind of Capitalism’s universal promulgation.
... Top management compensation structure and CEO pay, in particular, is another controversial topic in corporate governance with political ramifications. The emerging consensus among shareholders, employees, and politicians is that the corporate governance system is broken and requires a major revamp (Cardoso et al., 2019;Cooper et al., 2014;Forbes, 2014;Edmans et al., 2014a). SEC has recently mandated disclosure of the ratio of the CEO's pay to that of the median employee. ...
... Cooper's study found that 13% of the 150 CEOs who had done mergers over the previous year, and the average return reported of all mergers was negative .51%. Among the top-paid CEOs, 19% did mergers and those deals resulted in a negative return (-1.38%) over the following three years (Cooper et al., 2014). ...
... BOD and Stock-based compensation are considered effective designs to align the interests of managerial agents and shareholding principals. Recent studies, however, are increasingly indicating weak associations between firm performance, shareholder returns, and managerial stock-option(Cardoso et al., 2019;Cooper et al., 2014;Crumley, 2008; Heidrick & Struggles International European Corporate Governance Report, 2011). The inefficient conditions that prevail in the financial markets and their impact on management have natural implications for a rethinking of corporate governance. ...
Poster
Full-text available
In this manuscript, I would like to present a critique on free market idealism drawing from systems thinking juxtaposing the rational, and irrational tendencies and emotional predicaments of the human mind that defeat the lofty claims of free-market idealism. By offering some real evidence that contradicts the presumptions of free-market idealism, I would like to uncover some of its fallacies, inherent contradictions, intolerable inconsistencies concerning promoting economic growth and highlight its failure to sustain the quintessential economic/industrial activities that safeguard the interests of the larger society.
... Top management compensation structure and CEO pay, in particular, is another controversial topic in corporate governance with political ramifications. The emerging consensus among shareholders, employees, and politicians is that the corporate governance system is broken and requires a major revamp (Cardoso et al., 2019;Cooper et al., 2014;Forbes, 2014;Edmans et al., 2014a). SEC has recently mandated disclosure of the ratio of the CEO's pay to that of the median employee. ...
... Cooper's study found that 13% of the 150 CEOs who had done mergers over the previous year, and the average return reported of all mergers was negative .51%. Among the top-paid CEOs, 19% did mergers and those deals resulted in a negative return (-1.38%) over the following three years (Cooper et al., 2014). ...
... BOD and Stock-based compensation are considered effective designs to align the interests of managerial agents and shareholding principals. Recent studies, however, are increasingly indicating weak associations between firm performance, shareholder returns, and managerial stock-option(Cardoso et al., 2019;Cooper et al., 2014;Crumley, 2008; Heidrick & Struggles International European Corporate Governance Report, 2011). The inefficient conditions that prevail in the financial markets and their impact on management have natural implications for a rethinking of corporate governance. ...
... Top management compensation structure and CEO pay, in particular, is another controversial topic in corporate governance with political ramifications. The emerging consensus among shareholders, employees, and politicians is that the corporate governance system is broken and requires a major revamp (Cardoso et al., 2019;Cooper et al., 2014;Forbes, 2014;Edmans et al., 2014a). SEC has recently mandated disclosure of the ratio of the CEO's pay to that of the median employee. ...
... Cooper's study found that 13% of the 150 CEOs who had done mergers over the previous year, and the average return reported of all mergers was negative .51%. Among the top-paid CEOs, 19% did mergers and those deals resulted in a negative return (-1.38%) over the following three years (Cooper et al., 2014). ...
... BOD and Stock-based compensation are considered effective designs to align the interests of managerial agents and shareholding principals. Recent studies, however, are increasingly indicating weak associations between firm performance, shareholder returns, and managerial stock-option(Cardoso et al., 2019;Cooper et al., 2014;Crumley, 2008; Heidrick & Struggles International European Corporate Governance Report, 2011). The inefficient conditions that prevail in the financial markets and their impact on management have natural implications for a rethinking of corporate governance. ...
... This is because spectrum estimates at neighboring sample autocorrelations are widely independent, while the autocorrelation function reveals dependencies (Montgomery et al., 2015). In order to obtain the spectral density, the Fourier coefficients are a and b in the form of ( ) 22 2 kk kn P ab n  = +   (10) and smoothed consequently. Further, the Fourier coefficients reveal the following relationship using the identity cos sin . ...
... Additionally, Fujianti (2018) found that neither the educational background nor gender influences the company value significantly. Cooper et al. (2016) found that excess compensation on the management level negatively influences its stock price performance. ...
Article
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The attempt to predict stock price movements has occupied investors ever since. Reliable forecasts are a basis for investment management, and improved forecasting results lead to enhanced portfolio performance and sound risk management. While forecasting using the Wiener process has received great attention in the literature, spectral time series analysis has been disregarded in this respect. The paper’s main objective is to evaluate whether spectral time series analysis can produce reliable forecasts of the Aurubis stock price. Aurubis poses a suitable candidate for an investor’s portfolio due to its sound economic and financial situation and the steady dividend policy. Additionally, reliable management contributes to making Aurubis an investment opportunity. To judge if the achieved forecast results can be considered satisfactory, they are compared against the simulation results of a Wiener process. After de-trending the time series using an Augmented Dickey-Fuller test, the residuals were compartmentalized into sine and cosine functions. The frequencies, amplitude, and phase were obtained using the Fast Fourier transform. The mean absolute percentage error measured the accuracy of the stock price prediction, and the results showed that the spectral analysis was able to deliver superior results when comparing the simulation using a Wiener process. Hence, spectral time series can enhance stock price forecasts and consequently improve risk management.
... A recent study by Cooper et al. (2016) finds that higher CEO incentive compensation is associated with higher realized future returns. Based on the achievement of sustainable development objectives, the compensation plan makes it possible to align managers' interests with those of shareholders, which is likely to affect the determination of the cost of equity. ...
... A recent study by Cooper et al. (2016) finds that higher CEO incentive compensation is associated with lower realized future returns. Based on the achievement of sustainable development objectives, the compensation plan makes it possible to align managers' interests with those of shareholders, which is likely to affect the determination of the cost of equity. ...
Article
Purpose This paper aims to examine the effect of the corporate ethical approach on the cost of equity capital. This study is conducted on a large international sample on behalf of the world’s most engaged firms from an ethical point of view in 2015. Design/methodology/approach The multivariate linear regression model is used to meet the purpose of this study and research hypotheses are also examined using a sample of 80 of most ethical firms in the world during the year 2015. Moreover, three variables (i.e. business ethics, corporate social responsibility and executive compensation based on the achievement of sustainable development goals) are used to reflect the corporate ethical approach and the implied cost of equity capital is used for estimating the cost of equity. In this regard, equity cost estimation is the most appropriate approach to test the effect of business ethics on the cost of financing firms. Findings Based on a sample of 80 firms emerging as the world’s most ethical firms in 2015, the results revealed that firms with better ethics scores are significantly associated with a reduced cost of equity capital. This paper also demonstrates that the executive incentive pays that are based on the objectives of sustainable development are able to explain different outcomes regarding the relation between corporate ethical behaviors and the cost of equity. These findings support arguments in the literature that firms with socially responsible practices have a higher valuation and lower risk. Originality/value This study provides implications for global regulators and policymakers when setting social reporting standards, suggesting that corporate ethical engagement reduces the cost of equity capital by decreasing the information asymmetry and thereby reducing the firms’ risk. Therefore, the findings may be informative to international managers and investors when considering the effect of business ethics on the firm’s ex-ante cost of equity. In this perspective, the voluntary disclosure of information makes it possible to mitigate the problems of asymmetry of information and conflict of interest between the firm and its main providers of capital, which could reduce the cost of equity.
... The authors have argued that this finding is due to weak governance structures, which leads to excessive CEO compensation, which eventually yields poor firm performance. But Cooper, Gulen, and Rau (2014) have related the reported negative relationship, to the fact that stockholders seem to be more convinced than ever that there is no connection between executive pay and corporate performance, and any increase of CEO pay might reflect an excessive executive powerful. ...
... Nevertheless, and compared with the other firms of the sector, investors seem to not appreciate an increase in the CEO gross compensa- an increase of CEO compensation may reflect rather an excessive executive power (Cooper et al., 2014). ...
Article
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The paper investigates the impact of chief executive officer (CEO) compensation on firm performance from a sample of 155 listed French companies on SBF 120, over 2009–2018. Findings suggest that an increase in CEO compensation seems to improve the accounting‐based firm performance, nevertheless it hurts the firm stock market value. More pronounced results are reported when we control for sector compensation interactions. We argue that attractive compensation may improve the executive services in achieving shareholders' objectives, but investors seem to not appreciate a CEO compensation increase. Based on the agency theory, it might be argued that investors fear possible executive opportunistic behavior encouraging them to enjoy overcompensation.
... On the other hand, Holmstrom and Milgrom [30] and Aggarwal and Samwick [31] recommended that firms incentivize managers with effective payment policies in a project. Michael et al. [32] believe that high payment induces overconfidence and could lead to wealth losses, such as overinvestment and value-destroying mergers and acquisitions. In addition, Humphery-Jenner et al. [33] evaluated managers' overconfidence in overestimating the returns on investment. ...
... Holmstrom and Milgrom [30] and Aggarwal and Samwick [31] suggest that payments incentivize managers. Michael et al. [32] and Humphery-Jenner et al. [33] believe that managers with high payments are prone to be overconfident and to overinvest. The second hypothesis to test in our research is: ...
Article
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The purpose of the research is to examine the importance of financial rewards and managers’ motivations, including sustainable investment projects. For that, the role of financial motivation for managers is analysed to understand strategic priorities for sustainable investment policies. Panel data for non-financial listed companies in China are used to determine the best-fit values of the proposed model, and the results of the Lagrange multiplier (LM) and Hausman tests are discussed for sustainable investment strategies. The results demonstrate that both low-paid and highly-paid managers in valuable project firms tend to be conservative and that managers consolidate their positions through underinvestment. This finding is clear evidence that managers are reluctant to take a risk on sustainable investment strategies. However, highly-paid managers of non-valuable project firms are generally willing to obtain high productivity through advanced technologies. The results are also generalized for strategies that are related to project managers’ financial motivation to increase the efficiency of sustainable investment decisions.
... Importantly, our focus on the market's treatment of SBC distinguishes our paper from a separate stream of research that examines the impact of executive compensation on firm performance (e.g., Murphy 1999;Core et al. 2003). For example, Cooper et al. (2016) find that excess CEO compensation is associated with lower future operating performance and stock returns and increased analyst forecast errors. In contrast to this literature, we study a different construct (SBC granted to all employees) that affects valuation via a different mechanism (market participants' tendency to ignore SBC). ...
Article
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Stock-based compensation (SBC) reduces the value of shareholder equity, ceteris paribus, and is a significant and growing expense for many firms. Despite its valuation implications and its growing importance, anecdotal evidence suggests that market participants ignore SBC in valuation. We first find that firms with higher SBC exhibit both higher valuation ratios and lower returns, suggesting overvaluation. This pattern is stronger for firms with larger analyst coverage, implying that the sell-side optimism is an important driver of the overvaluation. We then examine how financial analysts treat SBC in their valuation models. We find that analysts exclude more expenses in their street earnings forecasts and provide more optimistically biased target prices for firms with higher SBC. A hand-collected sample of analyst reports indicates that analysts who ignore SBC in valuation derive optimistically biased price targets, whereas analysts who treat SBC as an expense are unbiased on average. Together, our evidence indicates that market participants’ failure to account for stock-based compensation as an expense leads to the overvaluation of equity.
... Mason et al. [2004] confirmed that the pay gap between the CEO and other executive members has a negative influence on organizational performance. Cooper et al. [2009] introduced future performance variables to study the lagging effect of pay gap and found that non-CEO compensation has positive incentive for future performance but the pay gap between the CEO and other executives is a negative disincentive to future performance. This conclusion provides us a new perspective that the incentive to pay for current performance and the impact of future performance is not the same. ...
Article
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The study aims at identifying the influence of interior pay gap between senior executives and ordinary employees on the organization’s future performance for listed Chinese firms. In addition, two other moderator variables have been included in the study referring management power as the percentage of senior managers holding “A” category shares for more than one position. The other one is managerial overconfidence defined as the change in management holdings by themselves (managers) positively. The paper is based on secondary data extracted from China’s ‘A’ listed companies in Shanghai and Shenzhen Stock Exchanges with a valid sample size of 1,189. After detailed analysis (Pearson correlation and regression) between the variables, it was found that there is a moderate positive relationship between the pay gap and firms’ future performance. The results further indicate that management power and overconfidence weaken the relationship between pay gap and corporate performance. The authors hope that this empirical study can guide the academicians intending to further excavate in this relatively uncharted area as well as the corporate body and top managers who seek some guidelines to formulate an effective pay plan.
... It was noted that the vast majority of the studies consulted state the positive effect of firm size on CEO pay (Tosi et al 2000;Zhou 2000;Baker & Hall 1998). Given the pervasive nature of this factor, many recent studies have controlled for firm size (De Wet 2013;Cooper, Gulen & Rau 2010). Tosi et al (2000) estimate that firm size could account for more than 40% of the variance in total CEO compensation. ...
Article
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South Africa's labour policies and the growing societal calls to better explain executive remuneration create a unique opportunity to examine the effects of race on CEO pay. This empirical research study sought to investigate the effects of race on the sensitivity of executive pay to corporate performance. The study aims to contribute to the literature by providing an evidence-based approach to understanding the effect of race on CEO remuneration. The research design was quantitative, descriptive and longitudinal in nature, utilising validated secondary data sources. The sample consisted of 19 black CEOs and a random sample of 45 white CEOs. All components of South African CEO remuneration studied were found to correlate strongly with PAT (Profit after Tax) and EBITDA (Earnings before Interest, Taxes, Depreciation and Amortisation) and to a lesser degree with ROE (Return on Equity) and HEPS (Headline Earnings per Share). Black and white CEO mean remuneration was found to show no significant difference as a result of race. A notable difference found was the higher degree of pay-performance sensitivity and variability seen within the black CEO sample. The study showed that race does not affect the level of CEO remuneration but does impact on pay-performance sensitivity and variability.
... Top management have in depth experience and know where and how to drain off firm's asset for benefits of controlling party. This is possible when CEO have well compensation policy and low risk which result from weak governance tools (Cooper, Gulen, & Rau, 2016) because CEO looks for benefits as well as for survival in future. CEOs in such situations easily commit fraud for the interest of dominant party (S. A. Johnson, Ryan, & Tian, 2009) and involved in overinvestment or in value destroying projects. ...
Article
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Tunneling, the most severe practice in non-financial firms, harm a firm's performance, bring lose to minority shareholders and discourage potential investors. Agency conflict between minority and majority shareholders causes tunneling activities to take place. This study is aimed at examining the influence of CEO compensation and cash holding on tunneling in the non-financial firms in Pakistan. Several statistical techniques and models (regression, Hausman model, fixed effect model etc.) have been applied to examine the subject phenomenon. Finding of the study shows that both cash holdings and CEO compensation have significant positive impact on tunneling and thus cause minority shareholders' expropriation. Firms usually pay good compensation and hold more cash to safeguard the benefits of controlling shareholders. Finding also confirms gradual increase in tunneling over a period. Study provide detailed examination of tunneling phenomenon to reshape the regulatory policies regarding concentrated firms and hence to flourish the new ventures.
... Dominant Executives probably exert their command in determining the strategic actions of the company, and may act on their behalf to the detriment of the shareholders (Brown & Sarma, 2007, p. 363). The second is the ratio of shares held by the CEO compared to the total volume of shares of the company (Cooper, Gulen, & Rau, 2013). The third is the participation of CEOs at the board, where the value 1 indicates they are a member of the board for company i at time t and 0 indicates otherwise (Shimizu, 2007). ...
Article
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Despite the relevance of frequent acquisitions as a corporate strategic program, little is known about the reasons for its occurrence. Studies focus on identifying the factors that determine the first acquisition, disregarding that companies can engage in successive events. To fill this gap, this study identifies the reasons that lead companies to become frequent acquirers, comparing them with what is already known about the motivations for the first acquisition. By Logistic and Poisson Regressions, we identified that the predictors of the first acquisition contribute to explain the frequency of occurrence of these events. Also, acquisition frequency can be considered a strategy to support business competitiveness, which has the executives' self-interest as its primary driver.
... Um executivo dominante provavelmente exerce o seu domínio na determinação das ações estratégicas da empresa, podendo agir em seu interesse em detrimento do dos acionistas (Brow & Sarma, 2007, p.363). A segunda, é a proporção de ações em posse do gestor em relação ao volume total de ações da empresa (Cooper, Gulen, & Rau, 2013). A terceira é a participação do gestor no conselho, em que o valor 1 indica que o gestor é membro do conselho para a empresa i no tempo t e 0 para o caso contrário (Shimizu, 2007). ...
Article
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Apesar da relevância das aquisições frequentes como um programa estratégico corporativo, sabe-se pouco sobre os motivos de sua ocorrência. Os estudos focam na identificação dos fatores que determinam a primeira aquisição, desconsiderando que as empresas podem se envolver em sucessivos eventos. Para preencher essa lacuna, este estudo identifica os motivos que levam as empresas a se tornarem adquirentes frequentes, comparando com o que já se sabe sobre as motivações para realização da primeira aquisição. Por meio de Regressões Logísticas e de Poisson, identificamos que os preditores da primeira aquisição contribuem para explicar a frequência desses eventos. Ainda, a frequência de aquisições pode ser vista como uma estratégia para manter a competitividade da empresa, cujo principal propulsor é o auto interesse dos principais executivos.
... Could they be regarded as a necessary evil?Quite the opposite seems to be true. A recent study finds a negative correlation between CEO pay and future trends in shareholder wealth for up to five years (Cooper et al., 2014). For example, firms that pay their CEOs in the top ten percent have abnormallynegative returns (approx. ...
... Cash compensation is the remuneration paid to the executives during the fiscal year. It may include base salary and cash bonuses (see, e.g., Cooper et al., 2014;Core et al., 1999;Croci et al., 2012) or may include base salary, cash bonuses and other cash benefits (see, e.g., Balafas et al., 2014;Conyon et al., 2012;Ntim et al., 2013). Other forms are included in non-cash compensation. ...
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The purpose of this study is to examine whether earnings management is influenced by executive compensation, concentrated/family ownership, or board structure in an emerging market. The study used an unbalanced panel data from non-financial firms listed at Pakistan Stock Exchange (PSX) and employed multiple regression with robust econometric estimation procedures. The study found that CEO compensation does not influence earnings management. Ownership concentration leads to higher earnings management while CEO duality reduces earnings management. In addition, family and concentrated ownership is mainly related to the downward earnings management. Furthermore, the study found that the larger boards lead to higher earnings management while the number of non-executive directors has no impact on earnings management. The study extended the limited research on the relationships between executive compensation, corporate governance and earnings management in Asian context. This study reported an emerging market where stock-based compensation does not exist, and CEOs do not engage in earnings management to increase their compensation. Furthermore, this study posed some challenges to existing studies by showing that ownership concentration, board size and CEO duality do have influences on earnings management in Pakistan.
... To allow us to examine whether bonuses have a differential effect on profitability, we also incorporate Log Salary and Log Other Compensation in our model. Control variables follow prior for-profit literature, which suggests that firm size (Log Total Assets), Age, Leverage, Percentage of Independent Directors, and Log Board Size (Balafas and Florackis 2014;Cooper et al. 2014;Balsam et al. 2016) all play an important role in predicting future performance. We define organizational age as the number of years since 501(c)(3) tax-exempt status was 15 Automatic extensions of six months are available. ...
Article
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We utilize information only recently disclosed on Form 990 to examine the use, and consequences of, incentive pay at nonprofit organizations. Bonuses are common in nonprofits, as we observe that approximately 45% of the 44,000 organization-year observations in our sample reported paying CEO bonuses. We find that the bonuses are positively associated with profitability, competition from other nonprofits, firm size, available cash, and use of compensation consultants and committees, while negatively related to board oversight, donations, and grants. Our results also suggest that donors look unfavorably at the payment of bonuses; that is, bonuses are associated with lower future donations. Nonetheless, we find evidence consistent with the payment of bonuses incentivizing nonprofit executives, as despite reduced fundraising, future profitability and program services are positively associated with current bonus compensation.
... Money is important in maintaining functional collaboration, however imprudent incentive structures can become detrimental. An example can be seen in high executive pay correlating to low company stock price (112). ...
Thesis
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Innovation is an often used yet poorly understood word. A critique of government policy to promote innovation demonstrates it to be incoherent and not informed by theory. Its fragmented approach is shown to not overcome market failures to innovate, while creating bureaucratic load for applicants. It is proposed that a deeper understanding of collaboration should inform government policies intended to promote market-based innovation. This research is a first approach by the author to understand, evaluate and improve collaborative performance, such as between business and research. An iterative, recursive methodology gathers data from interviews held with university commercialisation facilitators. It is found that a collaboration 'system' consists of five parameters that can be traced back to approach/avoid response of the mammalian brain. When the model is examined for feedback, a bias towards stability emerges, with innovation atypical. The parameter 'Identity' is critical in withstanding the instability of innovation. Leadership roles that optimise each of the parameters are discussed, as are reasons why government should not undertake them. This pragmatic understanding of collaboration theory allows crafting of coherent policy to promote innovation. The primary measure is subsidising of membership fees and audit of collaboration leadership, with a secondary measure being reduction of patent terms to five years to reduce costs associated with intellectual property. In combination, this policy builds an adaptive ecosystem of innovative collaboration, similar to Silicon Valley. Economies are grown by liberating under-employed human capacity using policy informed by a theory of collaborative entrepreneurial innovation systems (CEISYS).
... It is thus clear that this type of compensation is not widely applied in the organisations that participated in this research. The reason for this finding could well be that this type of compensation applies only to higher-level jobs in organisations, and not to those on the lower levels (Cooper, Gulen & Rau, 2016). 75 and 100% of the staff, in 17.7% to between 26 and 74%, in 10.1% to between 6 and 25% and in the case of 24.1% it applied to between 0 and 5% of their staff. ...
Technical Report
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This report provides the results of a survey of South African companies which pertain to the application of high performance work practices (HPWPs) in their organisations. The report provides an overview of the findings. The basis of the survey was a questionnaire completed by the financial, marketing and human resource managers of the companies that participated in the research. The report reflects the companies’ policies as at 2016, affording the companies an opportunity to benchmark themselves against other South African organisations and identify trends in human resource management practices.
... showed a negative coefficient, which indicates that where the relative CEO remuneration movement moves to a higher category the company is 2.37 times less likely to be classified as a top-performing company. This finding confirms speculation that CEO remuneration is not always based on merit and does not necessarily serve as an efficient incentive to align the objectives of management with those of shareholders and does not necessarily promote improved performance (Chamorro-Premuzic 2013;Cooper et al. 2009;Deysel and Kruger 2015). ...
Article
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Purpose Regulatory documents and the literature recommend individuals with various characteristics to be included on a board, which should improve the efficiency of the board and promote company performance. Stakeholders have different expectations from a company, for which the literature holds the board accountable. Shareholders, for example, want superior returns, while government requires the implementation of transformation initiatives, especially in South Africa. It will therefore be valuable to several interested parties to know which board characteristics are likely to promote their objectives. Design/methodology/approach Binary logistic regression is used to analyse the relationship between various board characteristics and the risk-adjusted performance of a company. The dataset comprised 170 companies, from the 13 largest sectors/subsectors of the Johannesburg Stock Exchange for the period 2009 to 2015. Findings Percentage female (negative), chief executive officer remuneration (negative), chairman remuneration (positive) and non-executive director remuneration (positive) and the payment gap (positive) showed statistically significant relationships with the odds that a company is categorised as a top performer based on its risk-adjusted return. Practical implications The findings inform various parties whether the benefits ascribed to the various board characteristics, by the literature and regulations, are actually obtained. Originality/value The study moved away from the practice of looking for linearity in corporate relationships and expanded the list of board characteristics reviewed. It used a risk-adjusted performance measure, introduced innovative diversity measures, and focussed on South Africa.
... A recent research study (Cooper, Gulen, and Rau, 2013) challenged the past two decades of academic research that argued chief executive officer (CEO) compensation should be aligned to firm performance. Such previous studies used small sample sizes in comparison to this new study. ...
Article
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CEO pay was correlated with market capitalization performance. Three simple correlation tests of 2013 total CEO pay with market capitalization destruction over the approximate three and one-half year period, January 2011 through July 2014, yielded a 66% weighted average moderate correlation for thirty-four companies. The total market cap destruction for these companies was an estimated $120.1 billion with total CEO pay of $224.6 million. Thus, total market cap destruction was approximately 535 times greater than total CEO pay. During this approximate three and one-half year time period, the S&P 500 Index increased 51.8%. Our simple correlation tests do not imply any causality. However, some corporate governance researchers (Kostyuk, 2014 and Hilb, 2008) have advocated: “Pay for Performance, not Presence” which could include such correlations as part of executive compensation packages from Board of Directors’ compensation committees. Claw-back provisions could be used for market capitalization destruction in evolving executive compensation packages.
... Why haven't these independent compensation committees been evaluating CEOs' performance in terms of stock price performance and accounting performance? A new study (Cooper, Gulen and Rau, 2013) reported that the more CEOs get paid, the worse their companies do over the next three years in terms of both stock price and accounting performances. The conventional wisdom among executive pay consultants, board of directors' compensation committees, and investors is that CEOs make the best decisions when they have more stock and stock options in their compensation packages. ...
Article
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These guidelines are developed for independent and competent Board Directors: Directors must have no material relationships with the company over the past year. Directors should have business savvy, a shareholder orientation, and a genuine interest in the company. Pay for performance, not presence, and use a mix of short and long-term performance measures for Directors’ compensation. Evaluate Directors’ performance over a three year period, using both stock price and accounting performance. Use claw-back provisions for Board members’ compensation if the firm does poorly, compared to its peers over this period. There should be a mix of skills for Board members, such as industry knowledge, experience, and expertise in financial accounting, risk management, and cyber security. There should be term and age limits for Board members. There should be women on Boards.
... Using a sample of non-financial firms listed in the KSE, Ejaz et al. (2019) show a significant and negative relationship between CEO compensation and corporate financial performance measured by Tobin's Q and EPS. Similarly, Cooper et al. (2014) and Malmendier and Tate (2009) find very similar results. On the other hand, Ozkan (2011), Tosi et al. (2000), Finkelstein and Boyd (1998) did not find any significant relationship between CEOs remuneration and corporate performance. ...
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This article investigates the impact of CEO attributes on corporate reputation, financial performance, and corporate sustainable growth in India. Using static panel data methodology for a sample of NSE listed leading 138 non-fnancial companies over the time-frame 2011 to 2018, we fnd that CEO remuneration and tenure maintains signifcant positive associations with corporate reputation, while duality and CEO busyness are found to be associated with corporate reputation negatively. The results also show that female CEOs and CEO remuneration are associated with corporate fnancial performance positively, whereas CEO busyness, as expected, holds a signifcant negative relationship with corporate fnancial performance. Moreover, the results demonstrate that CEO age is associated with corporate sustainable growth negatively, while tenure appears to have a signifcant and positive association with corporate sustainable growth. The results are robust to various tests and suggest that in the Indian context, demographic and job-specifc attributes of CEOs exert signifcant infuence on corporate reputation, fnancial performance, and corporate sustainable growth. The empirical findings would provide a basis for the shareholders and companies to identify areas of consideration when appointing CEOs and determining their roles and responsibilities.
... There are also other researches which use uncommon data to predict future stock prices. The data includes key people compensation (Cooper et al. 2016), satellite images (Donaldson and Storeygard 2016) and the pictures included in the news (Obaid and Pukthuanthong 2021). ...
Preprint
News events can greatly influence equity markets. In this paper, we are interested in predicting the short-term movement of stock prices after financial news events using only the headlines of the news. To achieve this goal, we introduce a new text mining method called Fine-Tuned Contextualized-Embedding Recurrent Neural Network (FT-CE-RNN). Compared with previous approaches which use static vector representations of the news (static embedding), our model uses contextualized vector representations of the headlines (contextualized embeddings) generated from Bidirectional Encoder Representations from Transformers (BERT). Our model obtains the state-of-the-art result on this stock movement prediction task. It shows significant improvement compared with other baseline models, in both accuracy and trading simulations. Through various trading simulations based on millions of headlines from Bloomberg News, we demonstrate the ability of this model in real scenarios.
... In recent years, CEO compensation has been a major and often controversial subject in the business media and has also been an important area of academic study. One concern is whether high levels of compensation reflect performance or whether other factors are at work (Bebchuk and Fried 2004;Cooper et al. 2016). This concern is particularly important with respect to merger and acquisition (M&A) activity in light of the relatively disappointing returns to acquisitions in recent decades (Officer et al. 2008). ...
Article
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We estimate the effect of acquisition performance and acquisition activity on CEO compensation for the full set of CEOs of large public U.S. corporations in the Execucomp database over the period 1992–2016. Most previous work has focused on publicly traded acquisition targets. We focus on the comparison between public and private targets, showing significant differences between the two. One primary finding, based on panel data regressions (using both fixed and random effects) is that the performance of private acquisitions, as measured by abnormal announcement returns, has a statistically significant positive effect of plausible economic magnitude on CEO compensation. Public acquisitions exhibit a smaller positive effect that is statistically insignificant. For both, acquisition activity (number of acquisitions) has a statistically significant positive effect on compensation. Our main results suggest that agency considerations are important for both public and private acquisitions but are more important for public acquisitions.
... In recent years, CEO compensation has been a major and often controversial subject in the business media and has also been an important area of academic study. One concern is whether high levels of compensation reflect performance or whether other factors are at work (Bebchuk and Fried 2004;Cooper et al. 2016). This concern is particularly important with respect to merger and acquisition (M&A) activity in light of the relatively disappointing returns to acquisitions in recent decades (Officer et al. 2008). ...
Chapter
To avert damage to economic activity for third parties (interest of society)
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The study investigated the relationship between executive compensation and performance of quoted consumer goods companies in Nigeria. To achieve the objective, executive compensation key proxy variables were used in the study, namely chief executive officers" salary and directors" cash compensation, while firms" performance which is the dependent variable on the other hand is represented by return on asset. Two hypotheses were formulated to guide the investigation and the statistical test of parameter estimates was conducted using Pearson Correlation Method. Ex-post facto research design was adopted and data for the study were obtained from the Nigerian Stock Exchange Factbook and the published annual financial reports of the selected consumer goods companies listed on Nigerian Stock Exchange (NSE) with data spanning from 2011-2018. Analyses of data indicated that chief executive officers" salary has negative and significant effect on performance of quoted consumer goods companies in Nigeria; while Board of directors" cash compensation has positive and insignificant effect on performance of quoted consumer goods companies in Nigeria. The study suggests among others that management and controlling of chief executive officers" salary is an important factor to be considered for maintaining, enhancing or boosting the performance of consumer goods companies in Nigeria.
Article
We document that backfilling in the ExecuComp database introduces a data-conditioning bias that can affect inferences and make replicating previous work difficult. Although backfilling can be advantageous due to greater data coverage, if not addressed, the oversampling of firms with strong managerial incentives and higher subsequent returns leads to a significant upward bias in abnormal compensation, pay-for-performance sensitivity, and the magnitudes of several previously established relations. The bias also can lead to one misinterpreting the appropriate functional form of a relation and whether the data support one compensation theory over another. We offer methods to address this issue. Received May 12, 2014; editorial decision May 10, 2016 by Editor David Hirshleifer.
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This paper examines the impact of Brexit on financial services regulation in relation to three areas linked to executive remuneration. They are: the bonus cap; the clawback of pay; and the level of disclosure required by shareholders with regard to details of directors’ remuneration. It will be argued that legally Brexit will have little impact on any of the three areas. UK legislation has already incorporated a great deal of EU legislation. The status quo of retaining such legal restrictions seems sensible in light of public sentiment towards unfairness in executive compensation and uncertainty towards the Brexit negotiations. Nevertheless, London faces stiff competition from other major international financial centres in a post-Brexit era. The loss of single passporting rights is also encouraging major banks to invest in other European financial centres. Brexit creates opportunities too. With the integration of digital technology, it is possible to create convenient platforms where investors can access reports on executive remuneration.
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Based on 1575 firms-year observations from French companies listed on the Paris stock exchange from 2009 to 2017, this research study investigates the linkage between accounting conservatism and highest-paid chief executive officers (CEOs) and if this linkage increases as executive remuneration-performance sensitivity increases. The study’s findings show that there is a negative association between accounting conservatism and highest-paid CEOs. These findings suggest that the highest-paid CEOs can manage and restrict managerial accounting choices for their own gains, and, in turn, this has a negative effect on accounting conservatism. Firstly, in order to achieve generally discretionary goals, they distort the accounting figures by overvaluing their companies’ gains. Secondly, the negative linkage between accounting conservatism and highest-paid CEOs increases when they receive greater remuneration incentives for accounting performance. These findings indicate that powerful CEOs are incentivized to adjust earnings since the greater incentives help them to inflate their companies’ accounting results; to distort accounting performance, and provide investors with misleading information. In turn, such actions generate the ex-post settling up problems and end, unfortunately, in fraudulent behaviors. This study contributes to the literature that studies the relationship between accounting conservatism and the highest-paid senior executives in order to identify accounting conservatism (Iwasaki, Otomasa, Shiiba, & Shuto, 2018; Li, Henry, & Wu, 2019; Haider, Singh, & Sultana, 2021).
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We demonstrate the existence of a positive relationship between CEO pay disparity and the yield spreads of seasoned corporate bonds, based on a panel data in the U.S. from 2001 to 2012. The evidence is robust against alternative measures of pay disparity, the inclusion of other determinants of yield spreads as well as industry and year effects, and the potential endogeneity problem. More supporting results from subsamples are presented, including those in the periods of pre- and post-subprime crisis, with varying degrees of agency problems related to free cash flow, with dissimilar default risk, and with different maturities. We further demonstrate that CEO pay disparity does not merely reflect, but rather goes beyond many factors of corporate governance in helping bondholders assess the risks they face. All together, these results convincingly show that pay disparity matters to bondholders.
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We develop a conceptual, game theoretic model to analyze say-on-pay and understand whether it benefits shareholders. We analyze the traditional delegated-governance structure wherein shareholders delegate CEO compensation decision to the board. The board has an informational advantage and can collude with management for private benefits. We contrast this with an alternate governance structure referred to as owner-governance where shareholders determine compensation. Firm performance is dependent on CEO effort and stochastic factors. Though such a model of say-on-pay does not exist in practice, it is useful in that the model and analysis sheds insight into the outcomes for the parties involved. In contrast to some prior empirical research, we find that that say-on-pay does not benefit shareholders. The analysis demonstrates the effect of stochastic factors on CEO performance and therefore on compensation. The model captures the effect of collusion between the CEO and the board, which is difficult to discern in practice because it is not explicit, but tacit. There are clear insights for corporate governance policy makers. First, contrary to popular sentiment we suggest that say-on-pay does not improve shareholder welfare, and nor does CEO incentive compensation for the most part, because luck is a major factor. Second, shareholders are better off trading say-on-pay for the right to fire board members by dismantling board entrenchment enabled by staggered boards and poison pills. Widely adopted staggered boards and poison pills make it prohibitively costly to remove and replace boards or a majority of board members.
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Orientation: Executive remuneration remains a controversial topic. A major concern is the perceived misalignment of executive remuneration with company performance. Key performance indicators (KPIs) represent the strategic focus areas that drive a company’s performance. Aligning executive remuneration, especially the long-term incentives (LTIs), with KPIs is, therefore, paramount in attaining company performance objectives. Research purpose: This study assessed the alignment of chief executive officer (CEO) LTI objectives and company KPIs for mining companies listed on the Johannesburg Stock Exchange (JSE). Motivation for the study: Prior research focused mainly on the relationship between short-term executive remuneration and company performance. The present study provides insights into the composition of CEO remuneration and whether CEO LTI objectives are aligned with company strategy. Research approach/design and method: The sample comprised 34 mining companies for the period 2010–2016. A standardised methodology was applied to measure LTIs and statistical techniques (descriptive statistics and a ratings analysis) were applied to assess the alignment between CEO LTI objectives and company KPIs. Main findings: Chief executive officer remuneration showed an increasing trend, with LTIs contributing more towards total CEO remuneration towards the end of the research period. A weak to moderate alignment was found between CEO LTI objectives and company KPIs. Practical/managerial implications: Improved, transparent governance is required to address the opaque disclosure on the alignment between company KPIs and the objectives of CEO LTIs. Contribution/value-add: The study demonstrated that annual (and integrated) report disclosures generally do not clearly describe company strategy (reflected by KPIs) nor is the link between KPIs and CEO LTI objectives always evident. Stakeholders thus may well question whether CEO remuneration is aligned to attaining sustainable company performance.
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This paper is the first of its kind using the variation in state corporate tax rates to investigate if they have any explanatory power in predicting variations in CEO pay. Specifically, this paper allows us to shed light on whether corporate tax cuts boost CEO pay? This paper, by using a difference-in-difference (DID) set up over the period 1994 to 2015, finds that corporate tax cuts statistically affect CEO pay among all publicly traded firms in the US. The magnitude of the effect increases among the S&P 500 and S&P 100. The paper further presents some interesting findings using three different measures of executive compensation.
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Purpose: The authors investigate how the stock market reacts to financial restatements using the restatements data from the United States Government Accountability Office (GAO-06-678). In particular, the purpose of this paper is to examine the long-run equity performance of the restating firms, for holding periods of one to five years after the announcements of restatements. Design/methodology/approach: This paper measures the long-run stock performance of restating firms with the buy-and-hold abnormal returns and time-series regression analyses based on Fama–French’s (1993) three-factor model and Carhart’s (1997) four-factor model. Findings: The authors find that restating firms significantly underperform in the long run compared with their peers matched by industry, size and book-to-market. Restating firms’ underperformance is confirmed with time-series regression analyses based on Fama–French’s (1993) three-factor model and Carhart’s (1997) four-factor model. Further, the authors find the negative long-run abnormal performance of restating firms is primarily driven by large firms. The authors also report that self-prompted restatements and improper revenue accounting-triggered restatements result in worse long-run abnormal performance. Originality/value: This paper is the first paper that thoroughly investigates the long-run stock returns of the firms that restate financial statements by fully considering the size effect.
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We conjecture that a firm's organization capital (OC) has a substitution effect on its executive pay-for-performance sensitivity (PPS) and empirically document a robust and significant substitution effect of OC on executive PPS. We use state-level unemployment insurance benefits as an instrumental variable for OC and show that the documented OC-PPS substitution effect is likely causal. Results are also robust to a stacked difference-in-differences estimation approach based on a quasi-natural experiment of exogenous CEO turnovers due to health-related issues. Our findings strongly suggest that greater OC substitutes for costly executive incentive compensation to sustain firm productivity and increase shareholder wealth.
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This article is an historical analysis of the U.S. labor movement’s shareholder activism during the 2000s, which was based on their pension-plan assets. During the previous decade, corporate governance had tilted to give shareholders greater voice in corporate decisions. The protagonists were public pension plans such as CalPERS. Come the 2000s, they were replaced by unions and union-influenced pension plans. Their agendas overlapped but union investors were distinctive in their use of shareholder activism to make companies more public-minded, raise labor’s organizing power, and challenge executive power by reliance not only on shareholder activism but also political activities. Labor’s signature issue was executive pay, which was a topic that that shareholder activists during the 1990s had avoided other than to push for stock-based pay. But three waves of corporate scandals during the following decade caused other shareholders to become skeptical of executive pay-setting methods. Union investors zeroed in on expensing and backdating of stock options, and fought for say on pay, the issue where they had the greatest impact. An interaction between private orderings and regulation now developed, whereby shareholder pay reforms found their way into law. With inequality a major social concern, unions repeatedly contrasted lofty executive pay to stagnant wages. Yet little was said about lofty payouts to shareholders, which may have been a more important driver of inequality than executive pay. The article ties corporate governance to larger social and political developments in the U.S., and to the labor movement, embedding corporate governance in historical context.
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New Zealand has continued to strengthen its financial reporting and auditing landscape after major corporate collapses highlighted audit failures contributing to investor losses. Jointly, investors have criticized exorbitant compensation paid to CEOs. While the PCAOB's (Public Company Accounting Oversight Board) emphasis on executive compensation has prompted several studies in the United States, this study is the first to examine executive compensation in the evolving setting of New Zealand. Specifically, we examine the incentive‐based components of CEO compensation arrangements, finding both short‐term incentive and stock option compensation to be significant and positively associated with audit fees. We also examine moderating effects of client governance factors and find evidence that internal governance (audit committee effectiveness, board resources, and board and audit committee diligence) moderates the association between short‐term incentive and stock option compensation, and audit fees. Taken together, our evidence suggests that auditors consider CEO performance‐linked compensation a risk factor and are pricing it into the financial statement audit, with client governance moderating this pricing effect.
Chapter
The financial crisis led to the worst depression since 1929. Only by massive economic programs could worse be prevented. Here Keynesian theory came into play. Only through globally agreed massive credit-financed government spending increases could depression be prevented. The banks had to be saved with tax money, as many banks had invested in the government bonds of weak European countries whose solvency was called into question. The sovereign debt crisis has emerged from the financial crisis. Against this background, the question arises of state regulations that limit the risk of banks. Such regulation of the financial markets has been urged by politicians and economists since the onset of the 2007 financial crisis. What has happened in the meantime? Were the right reforms implemented or could there be another financial crisis? After analyzing the causes of the crisis, the main reforms are examined below.
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Based on 1575 firms-year observations from French companies listed on the Paris stock exchange from 2009 to 2017, this research study investigates the linkage between accounting conservatism and highest-paid chief executive officers (CEOs) and if this linkage increases as executive remuneration-performance sensitivity increases. The study’s findings show that there is a negative association between accounting conservatism and highest-paid CEOs. These findings suggest that the highest-paid CEOs can manage and restrict managerial accounting choices for their own gains, and, in turn, this has a negative effect on accounting conservatism. Firstly, in order to achieve generally discretionary goals, they distort the accounting figures by overvaluing their companies’ gains. Secondly, the negative linkage between accounting conservatism and highest-paid CEOs increases when they receive greater remuneration incentives for accounting performance. These findings indicate that powerful CEOs are incentivized to adjust earnings since the greater incentives help them to inflate their companies’ accounting results; to distort accounting performance, and provide investors with misleading information. In turn, such actions generate the ex-post settling up problems and end, unfortunately, in fraudulent behaviors. This study contributes to the literature that studies the relationship between accounting conservatism and the highest-paid senior executives in order to identify accounting conservatism (Iwasaki, Otomasa, Shiiba, & Shuto, 2018; Li, Henry, & Wu, 2019; Haider, Singh, & Sultana, 2021).
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We examine the effect of international acquisitions on CEO compensation for U.S. firms from 1995 to 2016 using both domestic acquisition and no acquisition firms as benchmarks. We find that acquisitions lead to a greater increase in CEO compensation (especially incentive‐based compensation), which is consistent with agency theory and inconsistent with stewardship or reputation theory. We also find that international acquisitions lead to a greater increase in CEO incentive‐based compensation than domestic acquisitions, supporting matching theory given that international acquisitions are larger and more complex to manage. Additionally, we document that CEO tenure has a positive effect on CEO compensation, whereas firm relatedness has a negative effect on post‐acquisitions CEO compensation. This is the first study of its type based on comprehensive data, and it contributes to our understanding of the role of international and domestic acquisitions in CEO compensation. This article is protected by copyright. All rights reserved
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The Sarbanes Oxley Act of 2002 (SOX) introduced several governance reforms thatconsiderably increased the total risk exposure of CEOs. We examine the effects of these regulatory changes on compensation contracts of CEOs and their effect on risk taking subsequent to SOX. We find that while overall compensation did not change, salary and bonus compensation increased and option compensation decreased following the passageof SOX. The sensitivity of CEO s wealth to changes in shareholder wealth also decreasedafter SOX. These results indicate that the pay for performance sensitivity of CEOcompensation has declined following SOX. Our results indicate that these changesreduced investments in research and development, and capital expenditures. We also document that the above changes in CEOs pay for performance sensitivities and theirrisky investments following SOX are associated with a reduction in stock returnvolatility. However, we do not find any evidence indicating that these changes areassociated with lower future operating performance.
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The use of stock-based compensation as a solution to agency problems between shareholders and managers has increased dramatically since the early 1990s. We show that in a dynamic rational expectations model with asymmetric information, stock-based compensation not only induces managers to exert costly effort, but also induces them to conceal bad news about future growth options and to choose suboptimal investment policies to support the pretense. This leads to a severe overvaluation and a subsequent crash in the stock price. Our model produces many predictions that are consistent with the empirical evidence and are relevant to understanding the current crisis. (c) 2010 by the President and Fellows of Harvard College and the Massachusetts Institute of Technology..
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In this paper the financial incentives of executives are analyzed, theoretically and econometrically, with particular emphasis on the relationship between executive motivations and the sales-maximization hypothesis. Executive financial incentives are found to be primarily related to firm stock market performance. The sales performance of the firm has no consistent positive or negative effect on executive financial return. The structures of individual firms' compensation packages were tested for effects on firm performance. It was found that firms with executives whose financial rewards more closely paralleled stockholders' interests performed better in the stock market over the postwar period. For this sample of firms it was concluded that the hypothesis of present-value maximization better explains firm behavior than the hypothesis of sales maximization. It is the conclusion of this author that the sales-maximization hypothesis does not usefully characterize the "typical oligopolist," as has been asserte...
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This Article develops an account of the role and significance of managerial power and rent extraction in executive compensation. Under the optimal contracting approach to executive compensation, which has dominated academic research on the subject, pay arrangements are set by a board of directors that aims to maximize shareholder value. In contrast, the managerial power approach suggests that boards do not operate at arm's length in devising executive compensation arrangements; rather, executives have power to influence their own pay, and they use that power to extract rents. Furthermore, the desire to camouflage rent extraction might lead to the use of inefficient pay arrangements that provide suboptimal incentives and thereby hurt shareholder value. The authors show that the processes that produce compensation arrangements, and the various market forces and constraints that act on these processes, leave managers with considerable power to shape their own pay arrangements. Examining the large body of empirical work on executive compensation, the authors show that managerial power and the desire to camouflage rents can explain significant features of the executive compensation landscape, including ones that have long been viewed as puzzling or problematic from the optimal contracting perspective. The authors conclude that the role managerial power plays in the design of executive compensation is significant and should be taken into account in any examination of executive pay arrangements or of corporate governance generally.
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In this paper we review the academic evidence on earnings management and its implications for accounting standard setters and regulators. We structure our review around questions likely to be of interest to standard setters. In particular, we review the empirical evidence on which specific accruals are used to manage earnings, the magnitude and frequency of any earnings management, and whether earnings management affects resource allocation in the economy. Our review also identifies a number of opportunities for future research on earnings management.
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This article develops and applies new measures of portfolio performance which use benchmarks based on the characteristics of stocks held by the portfolios that are evaluated. Specifically, the benchmarks are constructed from the returns of 125 passive portfolios that are matched with stocks held in the evaluated portfolio on the basis of the market capitalization, book‐to‐market, and prior‐year return characteristics of those stocks. Based on these benchmarks, “Characteristic Timing” and “Characteristic Selectivity” measures are developed that detect, respectively, whether portfolio managers successfully time their portfolio weightings on these characteristics and whether managers can select stocks that outperform the average stock having the same characteristics. We apply these measures to a new database of mutual fund holdings covering over 2500 equity funds from 1975 to 1994. Our results show that mutual funds, particularly aggressive‐growth funds, exhibit some selectivity ability, but that funds exhibit no characteristic timing ability.
Article
ABSTRACT Two easily measured variables, size and book-to-market equity, combine to capture the cross-sectional variation in average stock returns associated with market {3, size, leverage, book-to-market equity, and earnings-price ratios. Moreover, when the tests allow for variation in {3 that is unrelated to size, the relation between market {3 and average return is flat, even when {3 is the only explanatory variable. THE ASSET-PRICING MODEL OF Sharpe (1964), Lintner (1965), and Black (1972)
Article
We examine the basic hypothesis that the market for managerial talent rewards managers from firms with superior stock price performance. We identify a set of outside CEO hires in a set of large publicly traded firms and investigate the stock price performance of the prior employers of these executives. Using 5-year buy-and-hold returns as our basic performance measure, we find that the prior employers of our sample executives did, on average, exhibit superior performance compared to a variety of benchmarks. A conditional logit analysis confirms that superior firm performance increases the likelihood that an executive will get an outside CEO job. Our results are most pronounced for executives who jump immediately from their prior employer to the new employer (raids) and for executives who were more highly ranked at their prior employer. We also examine compensation contracts and find that executives are typically awarded large initial hiring grants composed of stock options, restricted stock, and cash signing bonuses. These grants are highly correlated with the value of the unvested option and restricted stock position the executive leaves behind at his old employer. The evidence also suggests that these grants are positively related to prior firm performance, even after controlling for the forfeited position at the prior employer. We interpret our findings as providing substantial support for the basic hypothesis that superior stock price performance enhances an executive's external labor market opportunities. In our view this is an interesting and important finding, as it supports the basic assumption underlying a large class of models concerning executive decision making and contracting in the presence of career concerns.
Article
In this paper we review the academic evidence on earnings management and its implications for accounting standard setters and regulators. We structure our review around questions likely to be of interest to standard setters. Specifically, we review the empirical evidence on which particular accruals are used to manage earnings, the magnitude and frequency of any earnings management, and whether earnings management affects resource allocation in the economy. Our review identifies a number of important opportunities for future research on earnings management.
Article
This paper empirically investigates the influence of executive wealth diversification on firm equity granting patterns. Risk-averse, undiversified executives that hold substantial amounts of wealth in the firm, discount the value of their equity holdings, which increases costly risk-sharing and reduces incentives provided by equity grants. When executives divest equity from the firm, they insulate their wealth from firm-specific risk, thereby reducing costly risk-sharing and increasing the incentives of equity grants. This study investigates how firms respond to increases in executive wealth diversification that result from equity divestitures. The findings suggest that firms do not fully replenish divested incentives, but target greater equity incentives following an increase in executive wealth diversification. In addition, firms appear to increase the proportion of annual compensation in the form of equity after controlling for grants in response to deviations from equilibrium incentives. Overall, the results support agency theory predictions that wealth diversification is an important component of optimal contracting with undiversified, risk-averse managers.
Article
This paper proposes and implements a new method for investigating whether CEOs influence the terms of their own compensation. I analyze the dates of 591 stock option awards to CEOs of Fortune 500 companies in 1992 and 1993, finding that the timing of awards coincides with favorable movements in companies stock prices even though the awards remain secret for many months. Patterns of corporate earnings and dividend announcements suggest strongly that CEOs receive stock option awards shortly before favorable corporate news and that awards are delayed until after the release of adverse news. Analysis of abnormal volume data does not support the possibility that insider trading based on knowledge of the option awards can explain the stock price gains. The findings imply that top mangers can affect their companies processes for awarding stock options and exploit this influence in order to increase compensation.
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A sample of large industrial corporations is examined to determine whether there is a relationship between the levels of compensation received by the senior executives of those firms and the firms' economic performances. We find consistent evidence of such a relationship, with differences across firms in the total compensation of their three highest-paid officers being positively related to differences in both the common stock returns and operating profitability of the firms. The implication is that compensation packages are designed to reduce agency costs.
Article
Growth in capital expenditures conditions subsequent classification of firms to portfolios based on size and book-to-market ratios, as in the widely used Fama and French (1992, 1993) methods. Growth in capital expenditures also explains returns to portfolios and the cross section of future stock returns. These findings are consistent with recent theoretical models (e.g., Berk, Green, and Naik (1999)) in which the exercise of investment-growth options results in changes in both valuation and expected stock returns.
Article
The value premium in U.S. stock returns is robust. The positive relation between average return and book-to-market equity is as strong for 1929 to 1963 as for the subsequent period studied in previous papers. A three-factor risk model explains the value premium better than the hypothesis that the book-to-market characteristic is compensated irrespective of risk loadings.
Article
We predict and find that firms use annual grants of options and restricted stock to CEOs to manage the optimal level of equity incentives. We model optimal equity incentive levels for CEOs, and use the residuals from this model to measure deviations between CEOs’ holdings of equity incentives and optimal levels. We find that grants of new incentives from options and restricted stock are negatively related to these deviations. Overall, our evidence suggests that firms set optimal equity incentive levels and grant new equity incentives in a manner that is consistent with economic theory.
Article
This study examines the stock price reaction around the announcement of proposed changes in long-term managerial compensation packages. The evidence indicates that on average these plans are met with positive market reactions, i.e., shareholder wealth increases. Further, we are unable to differentiate the market reaction to various types of long-range compensation schemes. This result is consistent with the notion that firms with different characteristics will resolve their managerial compensation requirements differently. Thus no particular compensation package necessarily dominates all others.
Article
We present a model of mergers and acquisitions based on stock market misvaluations of the combining firms. The key ingredients of the model are the relative valuations of the merging firms and the market's perception of the synergies from the combination. The model explains who acquires whom, the choice of the medium of payment, the valuation consequences of mergers, and merger waves. The model is consistent with available empirical findings about characteristics and returns of merging firms, and yields new predictions as well.
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Does CEO overconfidence help to explain merger decisions? Overconfident CEOs over-estimate their ability to generate returns. As a result, they overpay for target companies and undertake value-destroying mergers. The effects are strongest if they have access to internal financing. We test these predictions using two proxies for overconfidence: CEOs’ personal over-investment in their company and their press portrayal. We find that the odds of making an acquisition are 65% higher if the CEO is classified as overconfident. The effect is largest if the merger is diversifying and does not require external financing. The market reaction at merger announcement (-90 basis points) is significantly more negative than for non-overconfident CEOs (-12 basis points). We consider alternative interpretations including inside information, signaling, and risk tolerance.
Article
Extant studies show that stock returns are abnormally negative before executive option grants and abnormally positive afterward. We find that this return pattern is much weaker since August 29, 2002, when the Securities and Exchange Commission requirement that option grants must be reported within two business days took effect. Furthermore, in those cases in which grants are reported within one day of the grant date, the pattern has completely vanished, but it continues to exist for grants reported with longer lags, and its magnitude tends to increase with the reporting delay. We interpret these findings as evidence that most of the abnormal return pattern around option grants is attributable to backdating of option grant dates.
Article
We provide empirical evidence on how the practice of competitive benchmarking affects chief executive officer (CEO) pay. We find that the use of benchmarking is widespread and has a significant impact on CEO compensation. One view is that benchmarking is inefficient because it can lead to increases in executive pay not tied to firm performance. A contrasting view is that benchmarking is a practical and efficient mechanism used to gauge the market wage necessary to retain valuable human capital. Our empirical results generally support the latter view. Our findings also suggest that the documented asymmetry in the relationship between CEO pay and luck is explained by the firm's desire to adjust pay for retention purposes and is not the result of rent-seeking behavior on the part of the CEO.
Article
This paper identifies five common risk factors in the returns on stocks and bonds. There are three stock-market factors: an overall market factor and factors related to firm size and book-to-market equity. There are two bond-market factors, related to maturity and default risks. Stock returns have shared variation due to the stock-market factors, and they are linked to bond returns through shared variation in the bond-market factors. Except for low-grade corporates, the bond-market factors capture the common variation in bond returns. Most important, the five factors seem to explain average returns on stocks and bonds.
Article
This paper investigates empirically how the value of publicly traded firms is affected by arrangements that protect management from removal. Staggered boards, which a majority of U.S. public companies have, substantially insulate boards from removal in either a hostile takeover or a proxy contest. We find that staggered boards are associated with an economically meaningful reduction in firm value (as measured by Tobin's Q). We also provide suggestive evidence that staggered boards bring about, and not merely reflect, a reduced firm value. Finally, we show that the correlation with reduced firm value is stronger for staggered boards that are established in the corporate charter (which shareholders cannot amend) than for staggered boards established in the company's bylaws (which shareholders can amend).
Article
This study documents that the abnormal stock returns are negative before unscheduled executive option awards and positive afterward. The return pattern has intensified over time, suggesting that executives have gradually become more effective at timing awards to their advantage, and possibly explaining why the results in this study differ from those in past studies. Moreover, I document that the predicted returns are abnormally low before the awards and abnormally high afterward. Unless executives possess an extraordinary ability to forecast the future market-wide movements that drive these predicted returns, the results suggest that at least some of the awards are timed retroactively.
Article
Firms that substantially increase capital investments subsequently achieve negative benchmark-adjusted returns. The negative abnormal capital investment/return relation is shown to be stronger for firms that have greater investment discretion, i.e., firms with higher cash flows and lower debt ratios, and is shown to be significant only in time periods when hostile takeovers were less prevalent. These observations are consistent with the hypothesis that investors tend to underreact to the empire building implications of increased investment expenditures. Although firms that increase capital investments tend to have high past returns and often issue equity, the negative abnormal capital investment/return relation is independent of the previously documented long-term return reversal and secondary equity issue anomalies.
Article
Compensation, status, and press coverage of managers in the United States follow a highly skewed distribution: a small number of “superstars” enjoy the bulk of the rewards. We evaluate the impact of CEOs achieving superstar status on the performance of their firms, using prestigious business awards to measure shocks to CEO status. We find that award-winning CEOs subsequently underperform, both relative to their prior performance and relative to a matched sample of non-winning CEOs. At the same time, they extract more compensation following the awards, both in absolute amounts and relative to other top executives in their firms. They also spend more time on public and private activities outside their companies, such as assuming board seats or writing books. The incidence of earnings management increases after winning awards. The effects are strongest in firms with weak corporate governance. Our results suggest that the ex post consequences of media-induced superstar status for shareholders are negative.
Article
This paper considers the features of the newly disclosed compensation peer groups and demonstrates their significant role in explaining variations in chief executive officer (CEO) compensation beyond that of other benchmarks such as the industry-size peers. After controlling for industry, size, visibility, CEO responsibility, and talent flows, we find that firms appear to select highly paid peers to justify their CEO compensation and this effect is stronger in firms where the compensation peer group is smaller, where the CEO is the chairman of the board of directors, where the CEO has longer tenure, and where directors are busier serving on multiple boards.
Article
We develop and analyze a model of a multi-stage investment project that captures many features of R&D; ventures and start-up companies. An important feature these problems share is that the firm learns about the potential profitability of the project throughout its life, but that "technical uncertainty" about the research and development effort itself is only resolved through additional investment by the firm. In addition, the risks associated with the ultimate cash flows the firm realizes on completion of the project have a systematic component, while the purely technical risks are idiosyncratic. Our model captures these different sources of risk, and allows us to study their interaction in determining the risk premia earned by the venture during development. Our results show that the systematic risk, and the required risk premium, of the venture are highest early in its life, and decrease as it approaches completion, despite the idiosyncratic nature of the technical risk.
Article
The authors' estimates of the pay-performance relation (including pay, options, stockholding, and dismissal) for chief executive officers indicate that CEO wealth changes $3.25 for every $1,000 changes in shareholder wealth. Although the incentives generated by stock ownership are large relative to pay and dismissal incentives, most CEOs hold trivial fractions of the firms' stock, and ownership levels have declined over the past fifty years. The authors hypothesize that public and private political forces impose constraints that reduce the pay-performance sensitivity. Declines in both the pay-performance relation and the level of CEO pay since the 1930s are consistent with this hypothesis. Copyright 1990 by University of Chicago Press.
Article
We construct a dynamic general equilibrium production economy to explicitly link expected stock returns to firm characteristics such as firm size and the book-to-market ratio. Stock returns in the model are completely characterized by a conditional capital asset pricing model (CAPM). Size and book-to-market are correlated with the true conditional market beta and therefore appear to predict stock returns. The cross-sectional relations between firm characteristics and returns can subsist even after one controls for typical empirical estimates of beta. These findings suggest that the empirical success of size and book-to-market can be consistent with a single-factor conditional CAPM model.
Article
We study firms adopting stock-option plans for outside directors in a sample of Fortune 1000 firms from 1997 to 1999. Fixed-effects models accounting for self-selectivity bias indicate that companies with such plans have higher market-to-book ratios and profitability metrics. Option plan adoptions generate positive cumulative abnormal returns (CARs) and favorable revisions in analysts' earnings forecasts. Outside director appointments produce CARs close to zero for firms with option plans but significantly negative CARs for firms without them. We conclude that such stock-option plans help align the incentives of outside directors and shareholders, thereby improving firm value.
Article
This paper develops a simple equilibrium model of CEO pay. CEOs have different talents and are matched to firms in a competitive assignment model. In market equilibrium, a CEO's pay depends on both the size of his firm and the aggregate firm size. The model determines the level of CEO pay across firms and over time, offering a benchmark for calibratable corporate finance. We find a very small dispersion in CEO talent, which nonetheless justifies large pay differences. In recent decades at least, the size of large firms explains many of the patterns in CEO pay, across firms, over time, and between countries. In particular, in the baseline specification of the model's parameters, the sixfold increase of U.S. CEO pay between 1980 and 2003 can be fully attributed to the sixfold increase in market capitalization of large companies during that period.
Article
Shareholder rights vary across firms. Using the incidence of 24 governance rules, we construct a "Governance Index" to proxy for the level of shareholder rights at about 1500 large firms during the 1990s. An investment strategy that bought firms in the lowest decile of the index (strongest rights) and sold firms in the highest decile of the index (weakest rights) would have earned abnormal returns of 8.5 percent per year during the sample period. We find that firms with stronger shareholder rights had higher firm value, higher profits, higher sales growth, lower capital expenditures, and made fewer corporate acquisitions. © 2001 the President and Fellows of Harvard College and the Massachusetts Institute of Technology
Article
The contracting view of CEO pay assumes that pay is used by shareholders to solve an agency problem. Simple models of the contracting view predict that pay should not be tied to luck, where luck is defined as observable shocks to performance beyond the CEO's control. Using several measures of luck, we find that CEO pay in fact responds as much to a lucky dollar as to a general dollar. A skimming model, where the CEO has captured the pay-setting process, is consistent with this fact. Because some complications to the contracting view could also generate pay for luck, we test for skimming directly by examining the effect of governance. Consistent with skimming, we find that better governed firms pay their CEO less for luck.
Article
Recent research suggests that implicit incentive contracts may be based on performance measures that are observable only to the contracting parties. We derive and test implications of this insight for the relationship between executive compensation and firm performance. If corporate boards optimally use both observable and unobservable (to outsiders) measures of executive performance and the unobservable measures are correlated with future firm performance, then unexplained variation in current compensation should predict future variation in firm performance. Further, compensation should be more positively associated with future performance when observable measures are less useful for contracting. Our results are consistent with these hypotheses.
Article
The role of imperfect information in a principal-agent relationship subject to moral hazard is considered. A necessary and sufficient condition for imperfect information to improve on contracts based on the payoff alone is derived, and a characterization of the optimal use of such information is given.
Article
The value premium in U.S. stocks returns is robust. The positive relation between average return and book-to-market equity (BE/ME) is as strong for 1929-63 as for the subsequent period studied in previous papers. Like others, we also find a size premium in stock returns. Small stocks have higher average returns than big stocks. The size premium is, however, weaker and less reliable than the value premium. The relations between average return and firm characteristics (size and BE/ME) are better explained by a three-factor risk model than by the behavioral hypothesis that investor overreaction causes characteristics to be compensated irrespective of risk loadings.
Article
Choking under pressure is defined as performance decrements under circumstances that increase the importance of good or improved performance. A model for choking on coordination and skill tasks is proposed, holding that the pressure increases the conscious attention to the performer's own process of performance and that this increased conscious attention disrupts the automatic or overlearned nature of the execution. Six experiments provided data consistent with this model. Three studies showed that increased attention to one's own process of performance resulted in performance decrements. Three other studies showed similar decrements produced by situational manipulations of pressure (i.e., implicit competition, a cash incentive, and audience-induced pressure). Individuals low in dispositional self-consciousness were shown to be more susceptible to choking under pressure than those high in it.
Article
We provide evidence of two variants of a dating game that entails picking a grant date ex post, that is, after the board's compensation decision is made: back-dating (picking a date before the board decision date), and forward-dating (waiting after the board decision date to observe the stock price behavior). Consistent with back-dating, we find stock return behavior around the grant date to be positively related to reporting lag. In the promptly reported sample, we find stock return behavior and the pattern of reporting lags consistent with forward-dating. Our calculations show that managers can obtain economically significant benefits by playing the dating game. , Oxford University Press.
Article
We find that executives who jump to chief executive officer (CEO) positions at new employers come from firms that exhibit above-average stock price performance. This relationship is more pronounced for more senior executives. No such relationship exists for jumps to non-CEO positions. Stock options and restricted stock do not appear to significantly affect the likelihood of jumping ship, but the existence of an “heir apparent” on the management team increases the likelihood that executives will leave for non-CEO positions elsewhere. Hiring grants used to attract managers are correlated with the equity position forfeited at the prior employer and with the prior employer's performance.
Article
We develop and analyze a model of a multi-stage investment project that captures many features of R&D ventures and start-up companies. An important feature these problems share is that the firm learns about the potential profitability of the project throughout its life, but that research and development effort itself is only resolved through additional investment by the firm. In addition, the risks associated with the ultimate cash flows the firm realizes on completion of the project have a systematic component, while the purely technical risks are idiosyncratic. Our model captures these different sources of risk, and allows us to study their interaction in determining the risk premia earned by the venture during development. Our results show that the systematic risk, and the required risk premium, of the venture are highest early in its life, and decrease as it approaches completion, despite the idiosyncratic nature of the technical risk.
Article
We consider how much of the top end of the income distribution can be attributed to four sectors -- top executives of non-financial firms (Main Street); financial service sector employees from investment banks, hedge funds, private equity funds, and mutual funds (Wall Street); corporate lawyers; and professional athletes and celebrities. Non-financial public company CEOs and top executives do not represent more than 6.5% of any of the top AGI brackets (the top 0.1%, 0.01%, 0.001%, and 0.0001%). Individuals in the Wall Street category comprise at least as high a percentage of the top AGI brackets as non-financial executives of public companies. While the representation of top executives in the top AGI brackets has increased from 1994 to 2004, the representation of Wall Street has likely increased even more. While the groups we study represent a substantial portion of the top income groups, they miss a large number of high-earning individuals. We conclude by considering how our results inform different explanations for the increased skewness at the top end of the distribution. We argue the evidence is most consistent with theories of superstars, skill biased technological change, greater scale and their interaction.
Article
The author, using 1981-86 data on more than 16,000 managers at 250 large corporations, investigates whether the sensitivity of managerial compensation to corporate performance in one year is positively related to corporate performance in the next year. Accounting-based measures of performance yield only weak evidence of such an association, but economic and market measures yield stronger evidence. Payment of an incremental 10% bonus for good economic performance is associated with a 30 to 90 basis point increase in the expected after-tax gross economic return in the following fiscal year; and payment of an incremental raise of 10% following a good stock market performance is associated with a 400 to 1200 basis point increase in expected total shareholder return. (Abstract courtesy JSTOR.)
Article
Workers in a wide variety of jobs are paid based on performance, which is commonly seen as enhancing effort and productivity relative to non-contingent pay schemes. However, psychological research suggests that excessive rewards can, in some cases, result in a decline in performance. To test whether very high monetary rewards can decrease performance, we conducted a set of experiments in the U.S. and in India in which subjects worked on different tasks and received performance-contingent payments that varied in amount from small to very large relative to their typical levels of pay. With some important exceptions, very high reward levels had a detrimental effect on performance.
Article
The use of stock-based compensation as a solution to agency problems between shareholders and managers has increased dramatically since the early 1990s. We show that in a dynamic rational expectations model with asymmetric information, stock-based compensation not only induces managers to exert costly effort, but also induces them to conceal bad news about future growth options and to choose suboptimal investment policies to support the pretense. This leads to a severe overvaluation and a subsequent crash in the stock price. Our model produces many predictions that are consistent with the empirical evidence and are relevant to understanding the current crisis.