The effect of financial reporting quality on CEO compensation structure: Evidence from accounting comparability

This study examines the effect of accounting comparability on the design of CEO compensation structure. After controlling for firm-specific attributes, we find that accounting comparability is positively associated with CEO equity-based compensation intensity and pay-performance sensitivity. This suggests that the improved comparability increases the usefulness of equity-based compensation and a firm is willing to offer more equity-based compensation contracts to CEOs and increase their pay-performance sensitivity. Further, we find that the impact of comparability on the CEO’s compensation contract increases with information asymmetry, which is consistent with the notion that accounting comparability is a quality of financial reporting that facilitates the use of equity-based compensation in a poor information environment. Our analysis also reveals that the effect of accounting comparability on CEO compensation structure is greater when a firm’s corporate governance is strong, consistent with the complementary relation between comparability and the exiting corporate governance in determining CEO compensation schemes. Overall, our evidence suggests that firms utilize more equity-based compensation as a proportion of total compensation under greater accounting comparability and enhance the alignment between equity-based compensation and firm performance.     

CEO compensation structure and firm performance

The objectives of our study are to estimate a model of ‘efficient’ compensation structure based on firm characteristics and test the performance consequences of deviation from the efficient compensation structure. Our results are based on 3503 firm years for the period from 1999 to 2005. The results suggest that firms whose CEOs receive compensation inconsistent with their firm characteristics have a lower performance compared to those firms whose CEOs’ compensation is consistent with their firms’ characteristics. Our measure of performance is based on both accounting and market‐based performance measures. Overall, our study provides some important new insights into the links between CEO compensation structure and firm performance.     

Do corporate governance mechanisms influence CEO compensation? An empirical investigation of UK companies

The aim of this paper is to empirically examine the influence of corporate governance mechanisms, that is, ownership and board structure of companies, on the level of CEO compensation for a sample of 414 large UK companies for the fiscal year 2003/2004. The results show that measures of board and ownership structures explain a significant amount of cross-sectional variation in the total CEO compensation, which is the sum of cash and equity-based compensation, after controlling other firm characteristics. We find that firms with larger board size and a higher proportion of non-executive directors on their boards pay their CEOs higher compensation, suggesting that non-executive directors are not more efficient in monitoring than executive directors. We also find that institutional ownership and block-holder ownership have a significant and negative impact on CEO compensation. Our results are consistent with the existence of active monitoring by block-holders and institutional shareholders. Finally, the results show that CEO compensation is lower when the directors’ ownership is higher.     

Reductions in CEO career horizons and corporate policies

We provide evidence on the effect of personal shocks that reduce a CEO's expected career horizon on corporate policies. The timing of these events is not predictable based on observable characteristics, and affected CEOs experience greater turnover rates and shorter residual time-in-office. Following the shock, these firms moderate both R&D and capital expenditures and increase cash distributions. While these changes are consistent with greater short-term orientation, they are not detrimental to shareholders, as performance increases after the shock. Earnings management and firm risk remain unchanged, while both CEO total compensation and equity-based compensation decline. Overall, our results indicates that the improved performance comes from the implementation of more efficient firm policies, likely driven by an internal tournament effect after the shock rather than from opportunistic behavior.     

Executive compensation and internal capital market efficiency

We document that chief executive officer (CEO) incentive compensation plays an important role in determining internal capital market (ICM) allocation efficiency. Our results suggest that CEO equity-based compensation can be effective in ameliorating inefficiencies in internal capital allocation decisions. We find that while stock grants play an important role in motivating CEOs to make more efficient internal capital allocation decisions, there is surprisingly no discernible influence of stock options. Our analysis supports the view that private benefits derived by managers are increasing in internal capital misallocation. We also document a strong positive link between CEO incentive compensation and excess value of diversified firms suggesting that the diversification discount can be ameliorated with CEO incentive compensation. The study contributes to the ICM literature and the literature on conglomerate diversification discount.     

Accounting fundamentals and CEO bonus compensation

Research indicates that there is a positive association between accounting earnings and chief executive officer (CEO) cash compensation; however, evidence also suggests that this positive association ceases to exist when earnings performance is poor or declining. This latter result has led some critics of corporate compensation policies to conclude that CEOs are not penalized for poor or declining firm performance. The purpose of this study is to further illuminate the pay-performance debate by expanding the traditional executive bonus compensation model to include a set of accounting fundamentals that prior research indicates are related to both current and future firm performance. Our results indicate that there is a highly significant relationship between accounting fundamentals and the level of and change in CEO bonus compensation. Moreover, we find a highly significant relationship between accounting fundamentals and both bonus omissions and bonus reductions. When earnings are negative or declining, we find that the above relationships remain intact. In contrast, when earnings are negative or declining, we find that the relationship between aggregate earnings and bonus compensation is weak or insignificant in most of our analyses. Taken together, our results suggest that the apparently weak relationship between accounting earnings and CEO bonus compensation (particularly when earnings are negative or declining) is partly due to the fact that the bonus compensation model excludes accounting fundamentals which are strongly associated with bonus compensation. Thus, we conclude that (i) bonus compensation is more closely tied to firm performance than critics sometimes claim and (ii) bonus compensation awarded to CEOs when earnings performance is poor is at least partially explained by the presence of favorable accounting fundamentals.     

Managerial Legacies,Entrenchment, and Strategic Inertia

This paper argues that the legacy potential of a firm's strategy is an important determinant of CEO compensation, turnover, and strategy change. A legacy makes CEO replacement expensive, because firm performance can only partially be attributed to a newly employed manager. Boards may therefore optimally allow an incumbent to be entrenched. Moreover, when a firm changes strategy it is optimal to change the CEO, because the incumbent has a vested interest in seeing the new strategy fail. Even though CEOs have no specific skills in our model, legacy issues can explain the empirical association between CEO and strategy change.     

Non-uniform effects of CEO equity-based compensation on firm performance – An application of a panel threshold regression model

We use panel-data threshold models to examine the non-uniform relation between Chief Executive Officer (CEO) equity-based compensation and earnings-based performance. Prior studies examining this very issue have arbitrarily adopted various exogenous criteria to partition the sample, and thus the inferences could be misleading. To address this issue, we employ the threshold regression models that allow the data itself to endogenously generate several regimes identified by the thresholds. Our empirical results show that not only is the positive impact of CEO equity incentives on firm performance more pronounced for companies with lower and moderate levels of CEO stock-based incentive pay, but also for less-profitable firms. The results are consistent with the position that excessive equity-based awards are unable to benefit firm performance, and that share-based compensation is more effective for start-up firms with low profit.     

CEO DIRECTORS,EXECUTIVE INCENTIVES,AND CORPORATE STRATEGIC INITIATIVES

I study how directors who are chief executive officers (CEOs) of other firms affect board effectiveness. I find that CEOs are paid more and their compensation is less sensitive to firm performance when other CEOs serve as directors. This is not an employment risk premium because CEO directors are not associated with higher turnover‐performance sensitivity. Also, CEO directors have no effect on corporate innovation but are associated with higher acquisition returns, especially for complex deals. My results suggest that the advisory benefits of CEO directors must be balanced against the distortions in executive incentives associated with their board service.     

CEO excess compensation: The impact of firm size and managerial power

Chief executive officer (CEO) compensation has received a great deal of attention over the past several decades. Critics assert that CEO compensation is “excessive” because it is only weakly linked to firm performance (i.e., managerial rent-extraction). On the other hand, defenders suggest that CEO compensation is “justified” given the incremental shareholder wealth created by CEOs, or that large CEO compensation packages merely reflect labor market forces. Prior research documents that CEO power and firm size are associated with larger compensation, but providing evidence that the larger compensation is excessive (i.e., not economically justified) has proven difficult. For each test firm we identify a potential replacement CEO (i.e., an executive-specific, within-country (US) compensation benchmark) and create an empirical test of excess compensation. We also examine the possibility that excess compensation is conditional upon firm size or CEO power. In spite of an inherent bias against finding excess compensation, the results suggest that the most powerful CEOs receive compensation that is not economically justified. We find no evidence of CEO excess compensation in the largest firms.     

The efficiency of compensation contracting in China: Do better CEOs get better paid?

Over recent years, China adopted a number of ‘western-style’ reforms of corporate governance and executive compensation. We investigate whether boards of Chinese firms evaluate CEO ability and remunerate their CEOs accordingly, an essential tenet of efficient compensation contracting. Using Data Envelopment Analysis to measure CEO ability, we do not find any evidence that CEO ability matters in compensation contracting decisions—it does not lead to either higher pay, stronger pay-for-performance sensitivity, or a higher likelihood of equity grants. This is surprising, since we find evidence that higher ability CEOs achieve superior firm performance. In contrast, we find that powerful CEOs do not overperform, while they enjoy large abnormal pay. Overall, our results suggest that Chinese firms fail to embrace new corporate governance reforms and are unable to fully utilize the reforms’ benefits.

     

Hedge fund activism,CEO turnover and compensation

This paper examines the governance role of hedge fund activists by analyzing the impact of these activists on CEO turnover, CEO pay, and CEO pay-performance link in targeted companies. Using the difference-in-difference approach, we first find significantly higher CEO turnover following hedge fund activism. After we split target companies into the CEO-turnover and non-CEO-turnover sub-samples, we find that only new CEOs in targeted companies get more compensation following hedge fund activism while incumbent CEO pay does not significantly change. The relationship between CEO bonuses and return on assets following hedge fund activism also differs across the subsamples split by CEO turnover. Pay-performance relationship is enhanced by hedge fund activism for new CEOs, but not for incumbent CEOs. In additional analyses, we document that CEO turnover is positively associated with Tobin’s Q and shareholder votes on Say on Pay in target companies after hedge fund activism.     

Changes in CEO compensation structure and the impact on firm performance following CEO turnover

We document changes in compensation structure following CEO turnover and relate them to future performance. Compared to outgoing CEOs, incoming CEOs derive a significantly greater percentage of their compensation from option grants and new stock grants. The voluntary turnover sample shows similar changes in compensation structure while the forced turnover sample results suggest that new stock grants drive the significant increase in incentive compensation following turnover. Post-turnover performance is positively associated with new stock grants as a percentage of total compensation in the full sample and when analyzing forced and voluntary turnovers separately. We find limited evidence that future operating income is positively associated with option grants following forced turnover. Post-turnover improvement in operating income is positively associated with an increase in new stock grants for the incoming relative to the outgoing CEO.

Star CEOs or Political Connections? Evidence from China's Publicly Traded Firms

This paper studies China's “star CEOs” defined as members of the National People's Congress (NPC) or the National Committee of the Chinese People's Political Consultative Conference (CPPCC) and “politically connected” CEOs who have previous government or military experience. We evaluate the effect of “star CEOs” and “politically connected” CEOs on firm performance and CEO compensation. We find that announcement date returns, CEO compensation and incentives are all higher in firms that appoint “star CEOs”. However, the mechanism explaining these various premiums is largely political connectedness of these star CEOs. Our study finds only modest evidence that star‐CEO status directly determines firm performance. Our analysis strongly suggests that compensation and performance premiums are mostly driven by CEO political connections, as opposed to CEO talent/star effects.     

Organizational complexity and CEO labor markets: Evidence from diversified firms

We examine whether CEO turnover and succession patterns vary with firm complexity. Specifically, we compare CEO turnover in diversified versus focused firms. We find that CEO turnover in diversified firms is completely insensitive to both accounting and stock-price performance, but CEO turnover in focused firms is sensitive to firm performance. Diversified firms also experience less forced turnover than focused firms. Following turnover, replacement CEOs in diversified firms are older, more educated, and are paid more when hired. Collectively, our results indicate that the labor market for CEOs is different across diversified and focused firms and that firm complexity and scope affect CEO succession.     

The effects of corporate acquisitions on CEO compensation and CEO turnover of family firms

This paper investigates the impact of corporate acquisitions on CEO compensation and CEO turnover of family firms in Continental Europe. We find that CEOs in family firms do not experience an increase in their compensation during the post-acquisition period, while there is a positive and statistically significant association between the compensation of CEOs in non-family firms and their acquisition activity. This finding is consistent with the view that controlling family shareholders provide monitoring for CEOs mitigating managerial agency problems that arise from the separation of ownership and control. Further, we find that the likelihood of CEO turnover declines following an acquisition in non-family firms, suggesting that these acquiring CEOs do not face a higher likelihood of dismissal while they receive a higher level of compensation. In contrast, there is no significant impact of acquisitions on CEO turnover in family firms.     

Compensation consultants and CEO pay

The study examines the practice of employing multiple compensation consultants. Examining data of a sample of UK companies over the period 2003–2006 we find that CEOs receive higher equity-based pay when firms employ more than one compensation consultant. An increase in the number of compensation consultants is also associated with an increase in CEO equity-based pay, whereas no decline in CEO pay takes place when firms reduce the number of pay consultants. We also observe that the market shares of compensation consultant are positively related to CEO equity-based pay.     

Can CEO dismissals be proactive?

We find significant variation in the prior stock returns of firms that dismiss their CEOs between 1996 and 2008. 49% of firms that dismiss their CEOs do so in the absence of negative industry-adjusted stock returns prior to dismissal (37% dismiss in the absence of negative raw returns). We find evidence for two reasons why boards may dismiss CEOs early, i.e., in the absence of significant poor prior stock performance. First, we find that early dismissals are more likely to be associated with corporate scandals, suggesting that CEOs that are found to engage in unethical or illegal activities are dismissed although their actions may not have a significant adverse impact on firm value. Second, we find support for the argument that early dismissals are proactive actions by boards to dismiss low ability CEOs. We find that firms with more equity-based compensation for directors and higher independent director ownership are more likely to dismiss their CEOs early. Boards with strong incentives are more likely to be proactive and act on their private information about the CEO than boards with poor incentives. Early dismissal firms experience a short-lived decline in operating performance around the date of CEO dismissal, and their operating performance recovers immediately after the CEO is replaced. On the other hand, the operating performance of late dismissal firms declines significantly prior to dismissal and improves substantially after dismissal. We also find that CEOs that are dismissed early are not more likely to find new CEO positions than CEOs that are dismissed late, supporting the idea that early dismissal CEOs may not have different ability than late dismissal CEOs.     

CEO compensation and future shareholder returns: Evidence from the London Stock Exchange

This study examines the ex-post consequences of CEO compensation for shareholder value. The main objective is to explore whether companies that pay their CEO excessive fees (in comparison to those of peer firms in the same industry and size group) generate superior future returns and better operating performance. Our analysis, which separately considers the cash-based and incentive/equity-based components of CEO compensation, is based on a large sample of UK-listed companies over the period 1998–2010. We find that CEO incentive pay is negatively associated with short-term subsequent returns. Interestingly, firms that pay their CEOs at the bottom of the incentive-pay distribution earn positive abnormal returns and, also, significantly outperform those at the top of the incentive-pay distribution. Further analysis reveals that such outperformance can be largely explained by the excessive exposure of low-incentive-pay firms to idiosyncratic risk. Finally, evidence from panel regressions suggests that, in addition to its negative relationship with returns, incentive pay is also inversely associated with future operating performance.     

Do CEOs gain more in foreign acquisitions than domestic acquisitions?

This paper examines the impact of domestic and foreign acquisitions on chief executive officer (CEO) compensation packages using a sample of 147 completed bids by UK companies from 1999 to 2005. We find that foreign acquisitions lead to higher CEO compensation than domestic acquisitions. Overall, our findings suggest that CEOs have strong incentives to do foreign acquisitions rather than domestic acquisitions since they receive larger compensation following a foreign acquisition regardless of how poor firm performance is. Furthermore, we observe a positive and significant relation between CEO compensation and firm size during the pre-acquisition period for firms involved in foreign acquisitions, thus their CEOs would expect to increase their compensation package through foreign acquisitions. However, our results show that there is no significant link between firm size and CEO compensation during the pre-acquisition period for firms involved in domestic acquisitions.