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Firm Competition and CEO Turnover: Evidence from US Railroad Deregulation: Firm Competition and CEO Turnover
Abstract
In this article, I examine how changes in the competitive environment of firms affect matches between chief executive officers (CEOs) and firms. I exploit the 1980 Staggers Rail Act, which drastically deregulated the freight railroad industry, as a source of arguably exogenous variation in the operating environment. Using hand-collected data, I obtain three main findings: first, CEO turnover rates increase; second, relative to utility firms, railroad CEOs have more business education and show broader work experience after deregulation; and third, firm performance leads to CEO turnover only during the regulated period.
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We examine explanations for corporate financing-, dividend-, and compensation-policy choices. We document robust empirical relations among corporate policy decisions and various firm characteristics. Our evidence suggests contracting theories are more important in explaining cross-sectional variation in observed financial, dividend, and compensation policies than either tax-based or signaling theories.
Since the seminal work of Katz and Murphy (1992), the study of wage inequality has taken as its starting point a neoclassical CES production function using as inputs capital and low and high skill labor. This approach assumes that the organization of production is fixed and determined by a particular specification of technology, and ignores both the source of the interaction between workers, and the organizational aspects of this interaction. These shortcomings are particularly important in the light of growing empirical evidence that points, first, to the importance of decreases in the cost of processing and communicating information and, second, to the complementar- ity between organizational change and adjustments in the distribution of wages (e.g. Bresnahan, Brynjolfsson and Hitt (2002)). This paper argues that theories that seek to guide empirical research on these areas must put knowledge and information at the center of the analysis of organizations and link the organizational structure with aggregate variables via equilibrium frameworks. Garicano and Rossi-Hansberg (2003) presents a model with these characteristics. It determines the organizational structure, as manifested by communication and spe- cialization patterns, and the implied wage structure, that result from different costs of acquiring and communicating information. Here, we present a simple variant of this theory that allows us to focus on one of the main aspects of that framework: the sorting of agents into teams and the wage and organizational structure that accom- panies that sorting. We use this simple model to analyze the changes in organization
This paper examines CEO pay in the banking industry and the effect of deregulating the market for corporate control. Using panel data on 147 banks over the 1980s, we find higher levels of pay in competitive corporate control markets, i.e., those in which interstate banking is permitted. We also find a stronger pay-performance relation in deregulated interstate banking markets. Finally, CEO turnover increases substantially after deregulation. These results provide evidence of a managerial talent market — one which matches the level and structure of pay with the competitiveness of the banking environment.
Between 1970 and 1997, the nation's railroads engaged in corporate mergers in an effort to stem the decline of the industry's market base, increase low return on investments, and counter the deterioration of trackage and equipment. The 73 Class I carriers in existence in 1970 have been consolidated into only 10 today. The recent battle over Conrail is only the most recent and highly publicized example of this trend that resulted from the relaxation of federal regulation. Business scholars, economists, railroad buffs, and anyone interested in transportation and federal regulation will find this book an invaluable tool.
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.
We show that pay is higher for chief executive officers (CEOs) with general managerial skills gathered during lifetime work experience. We use CEOs' résumés of Standard and Poor's 1,500 firms from 1993 through 2007 to construct an index of general skills that are transferable across firms and industries. We estimate an annual pay premium for generalist CEOs (those with an index value above the median) of 19% relative to specialist CEOs, which represents nearly a million dollars per year. This relation is robust to the inclusion of firm- and CEO-level controls, including fixed effects. CEO pay increases the most when firms externally hire a new CEO and switch from a specialist to a generalist CEO. Furthermore, the pay premium is higher when CEOs are hired to perform complex tasks such as restructurings and acquisitions. Our findings provide direct evidence of the increased importance of general managerial skills over firm-specific human capital in the market for CEOs in the last decades.
I present new stylized facts on the market for managers over the twentieth century, utilizing a novel data set on managerial careers. From the 1930s to the mid-1970s, the level of executive pay, inequality among executives across and within firms, and mobility were low. These patterns have reversed since then. I document that an increase in the importance of general managerial human capital can account for this change. The level of general skills, measured by the type of education and occupational mobility of managers, correlate with higher pay and turnover. Other factors may have also contributed to these changes, but the labor market for managers has likely played an important role.
This paper was accepted by Wei Jiang, finance.
We revisit the empirical relation between CEO turnover and firm performance. We find that boards aggressively fire CEOs for poor performance, and that the turnover-performance sensitivity increases substantially with board quality. In the first five years of tenure, CEOs who perform in the bottom quintile are 42 percentage points more likely to depart than CEOs in the top quintile. This spread increases to more than 70 percentage points for firms with high quality boards. The turnover-performance spreads remain high for seasoned CEOs in tenure years six to ten, but diminish considerably for the most seasoned CEOs. Our results, based on a new empirical approach, are significantly stronger than in prior research, and show that the threat of performance-induced dismissal is an important source of incentives for most CEOs. We also find tentative evidence that board quality is associated with higher stock returns following performance declines, suggesting that strong boards are more effective at dealing with negative performance shocks.
The quiet life hypothesis posits that firms with market power incur inefficiencies rather than reap monopolistic rents. We propose a simple adjustment to Lerner indices to account for the possibility of foregone rents to test this hypothesis. For a large sample of U.S. commercial banks, we find that adjusted Lerner indices are significantly larger than conventional Lerner indices and trending upward over time. Instrumental variable regressions reject the quiet life hypothesis for cost inefficiencies. However, Lerner indices adjusted for profit inefficiencies reveal a quiet life among U.S. banks.
This paper explores the impact of target CEOs’ retirement preferences on the incidence, the pricing, and the outcomes of takeover bids. Mergers frequently force target CEOs to retire early, and CEOs’ private merger costs are the forgone benefits of staying employed until the planned retirement date. Using retirement age as an instrument for CEOs’ private merger costs, we find strong evidence that target CEO preferences affect merger patterns. The likelihood of receiving a takeover bid increases sharply when target CEOs reach age 65. The probability of a bid is close to 4% per year for target CEOs below age 65 but increases to 6% for the retirement-age group, a 50% increase in the odds of receiving a bid. This increase in takeover activity appears discretely at the age-65 threshold, with no gradual increase as CEOs approach retirement age. Moreover, observed takeover premiums and target announcement returns are significantly lower when target CEOs are older than 65, reinforcing the conclusion that retirement-age CEOs are more willing to accept takeover offers. These results suggest that the preferences of target CEOs have first-order effects on both bidder and target behavior.
Thirty years have passed since the Staggers Act was signed into law and we can now take a fairly long measure of how well it has lived up to its promise. We can also venture some guesses as to what is in store for U.S. railroads and their shippers in the first half of the new century. We argue in this article that the Staggers Act has lived up to its promise, delivering early, substantially, and over a long period of time. However, railroad productivity growth in the years ahead will likely be less than what was experienced in the decades after Staggers, though it should be enough to sustain the industry. The interesting question is how the struggle will play out between railroads and shippers over who will capture the greater share of those gains.
We report evidence on chief executive officer (CEO) turnover during the 1971 to 1994 period. We find that the nature of CEO turnover activity has changed over time. The frequencies of forced CEO turnover and outside succession both increased. However, the relation between the likelihood of forced CEO turnover and firm performance did not change significantly from the beginning to the end of the period we examine, despite substantial changes in internal governance mechanisms. The evidence also indicates that changes in the intensity of the takeover market are not associated with changes in the sensitivity of CEO turnover to firm performance.
This paper studies the effect of product market competition on the compensation packages that firms offer to their executives. We use a panel of US executives in the 1990s and exploit two deregulation episodes in the banking and financial sectors as quasi-natural experiments. We provide difference-in-differences estimates of their effect on (1) total pay, (2) estimated fixed pay and performance-pay sensitivities, and (3) the sensitivity of stock option grants. Our results indicate that the deregulations substantially changed the level and structure of compensation: the variable components of pay increased along with performance-pay sensitivities and, at the same time, the fixed component of pay fell. The overall effect on total pay was small.
The management structure of U.S. railroads has been historically characterized as static and bureaucratic. Many writers have attributed this to years of restrictive government regulation. This paper tests the hypothesis that observable characteristics and organizational structure of railroad management have changed in conjunction with recent regulatory reform. Management characteristics are analyzed in both 1977 and 1983. Major findings are that managers in 1983 are significantly younger and better educated with fewer years of company and industry service. Railroad organizational structures are also reviewed before and after deregulation to assess whether management structures are becoming leaner and less mechanistic.
There is considerable and widespread concern about whether CEOs are appropriately punished for poor performance. The empirical literature on CEO turnover documents that CEOs are indeed more likely to be forced out if their performance
is poor relative to the industry average. However, CEOs are also more likely to be replaced if the industry is doing badly. We show that these empirical patterns are natural and efficient outcomes of a competitive assignment model in which CEOs and firms form matches based on multiple characteristics, and where industry conditions affect the outside options of both managers and firms. Our model also has several new predictions about the type of replacement manager, and their pay and performance. We construct a dataset which describes all turnover events during the period 1992-2006 and show that these predictions are also born out empirically.
This book provides a detailed account of how structural flaws in corporate governance have enabled managers to influence their own pay and produced widespread distortions in pay arrangements. The book also examines how these flaws and distortions can best be addressed. Part I of the book (titled The Official View and its Limits) critically examines the arm's length contracting view, which underlies much of the academic research on executive compensation as well as the law's approach to it. We show that boards have not been operating at arm's length from the executives whose pay they set. While recent reforms can improve matters, they cannot be expected to eliminate significant deviations from arm's length contracting. We also show that the constraints imposed by market forces and shareholders' power to intervene are not tight enough to prevent such deviations. Part II of the book (titled Power and Pay) shows how an understanding of the role of managerial power can help explain executive compensation practices. We provide a framework for assessing whether pay arrangements are a product of managerial influence. We discuss managers' interest in camouflaging the amount and the performance-insensitivity of their pay. Applying our framework, we discuss how managerial influence can help explain, among other things, the evidence on the relationship between managerial pay and managerial power; the use of retirement benefits and other compensation arrangements to provide stealth compensation; and the ability of departing managers to obtain more than their contractual entitlement.Part III of the book (titled Decoupling Pay from Performance) examines how managerial influence has operated to reduce the performance-sensitivity of executive pay. Among other things, we examine the structure of non-equity compensation, the design of conventional option plans, the use of restricted stock grants, and managers' freedom to unload options and shares.Part IV of the book (titled Going Forward) discusses how executive compensation - and corporate governance more generally - can be improved. We examine the extent to which pay arrangements can be improved by adopting board process rules, imposing shareholder approval requirements, and making pay more transparent. We conclude that problems with compensation arrangements cannot be fully addressed without ensuring that directors focus on shareholder interests and operate at arm's length from the executives whose compensation they set. To achieve this result, we argue, it is not sufficient to make directors independent of executives as recent reforms has sought to do; it is also necessary to make directors dependent on shareholders by changing the legal arrangements that insulate boards from shareholders.The preface and introduction are available to download at the bottom of this page. Also available for downloading from SSRN are three papers on which the book partly draws:- Lucian Bebchuk and Jesse Fried, "Stealth Compensation via Retirement Benefits," http://ssrn.com/abstract=583861- Lucian Bebchuk and Jesse Fried, "Executive Compensation as an Agency Problem," Journal of Economic Perspectives, Vol. 17, pp. 71-92, 2003, http://ssrn.com/abstract=364220- Lucian Bebchuk, Jesse Fried, and David Walker, "Managerial Power and Rent Extraction in the Design of Executive Compensation," University of Chicago Law Review, Vol. 69, pp. 751-846, 2002, http://ssrn.com/abstract=316590
In a recent book, Pay without Performance: The Unfulfilled Promise of executive Compensation, we critique existing executive pay arrangements and the corporate governance processes producing them, and put forward proposals for improving both executive pay and corporate governance. This paper provides an overview of the main elements of our critique and proposals. We show that, under current legal arrangements, boards cannot be expected to contract at arm’s length with the executives whose pay they set. We discuss how managers’ influence can explain many features of the executive compensation landscape, including ones that researchers subscribing to the arm’s length contracting view have long viewed as puzzling. We also explain how managerial influence can lead to inefficient arrangements that generate weak or even perverse incentives, as well as to arrangements that make the amount and performance-insensitivity of pay less transparent. Finally, we outline our proposals for improving the transparency of executive pay, the connection between pay and performance, and the accountability of corporate boards.
This paper reconciles two pronounced trends in U.S. corporate governance: the increase in pay levels for top executives, and the increasing prevalence of appointing CEOs through external hiring rather than internal promotions. We propose that these trends reflect a shift in the relative importance of "managerial ability" (transferable across companies) and "firm-specific human capital" (valuable only within the organization). We show that if the supply of workers in the corporate sector is relatively elastic, an increase in the relative importance of managerial ability leads to fewer promotions, more external hires, and an increase in equilibrium average wages for CEOs. We test our model using CEO pay and turnover data from 1970 to 2000. We show that CEO compensation is higher for CEOs hired from outside their firm, and for CEOs in industries where outside hiring is prevalent.
Much of our understanding of corporations builds on the idea that managers, when they are not closely monitored, will pursue goals that are not in shareholders' interests. But what goals would managers pursue? This paper uses variation in corporate governance generated by state adoption of antitakeover laws to empirically map out managerial preferences. We use plant-level data and exploit a unique feature of corporate law that allows us to deal with possible biases associated with the timing of the laws. We find that when managers are insulated from takeovers, worker wages (especially those of white-collar workers) rise. The destruction of old plants falls, but the creation of new plants also falls. Finally, overall productivity and profitability decline in response to these laws. Our results suggest that active empire building may not be the norm and that managers may instead prefer to enjoy the quiet life.
Traditional concerns about concentration in product markets have centered on the social loss associated with the mispricing that occurs when market power is exercised. This paper focuses on a potentially greater loss from market power - a reduction in cost efficiency brought about by the lack of market discipline in concentrated markets. We employ data from the commercial banking industry, which produces very homogeneous products in multiple markets with differing degrees of market concentration. We find the estimated efficiency cost of concentration to be several times larger than the social loss from mispricing as traditionally measured by the welfare triangle. © 2000 by the President and Fellows of Harvard College and the Massachusetts Institute of Technolog
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.
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.
I examine empirically whether the executive labor market helps to slot managers with higher education quality into jobs where they can obtain greater returns from their human capital skills. Comparing a sample of regulated gas and electric firms with manufacturing firms, I find that utilities attract CEOs with a lower-quality education than do unregulated firms. Comparing a sample of airline firms pre- and postderegulation, airlines have CEOs with a higher-quality education postderegulation. These results suggest that the labor market slots CEOs with a lower quality of education into regulated business environments.
This paper studies the effect of changes in foreign competition on the incentives faced by U.S. managers in the form of wage structures, promotion profiles, and job turnover. We use a panel of executives and measure foreign competition as import penetration. Using tariffs and exchange rates as instrumental variables, we estimate the causal effect of globalization on the labor market outcomes of these workers. We find that higher foreign competition leads to more incentive provision in a variety of ways. First, it increases the sensitivity of pay to performance. Second, it raises the return to a promotion and increases pay inequality among the top executives of the firm, with CEOs typically experiencing wage increases while lowerranking executives see their wages fall. Third, higher competition is associated with a higher probability of leaving the firm. Finally, we show that higher foreign competition also is associated with a higher demand for talent at the top of the firm. These results indicate that increased foreign competition can explain some of the recent trends in compensation structures.
This paper develops a framework to analyze the long-run adjustment of U.S. industries to economic deregulation, highlighting the role of intensified competition, innovations in operations, marketing, and technology, and adjustments to external shocks. The author applies this framework to industries that have recently undergone substantial deregulation--airlines, motor carriers, railroads, banks, and natural gas--and concludes that these industries have become far more efficient because of deregulation and provided large benefits to consumers. He concludes that the same adjustment process and positive outcome for consumers will result from the forthcoming deregulation of communications and electricity. Copyright 1998 by American Economic Association.
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