Relative performance evaluation, pay-for-luck, and double-dipping in CEO compensation

Relative performance evaluation, pay-for-luck, and double-dipping in CEO compensation We investigate whether chief executive officer (CEO) pay is linked to firm-specific and/or industry-wide performance only when it results in higher compensation. We argue CEOs have incentives to influence the ex post implementation of both relative performance evaluation (RPE) and pay-for-luck (PFL). Specifically, CEOs prefer RPE only when they outperform their reference group regardless of industry performance. Similarly, CEOs prefer PFL only when industry conditions are favorable. CEOs will try, ex post, to influence compensation committees to implement RPE and/or PFL only when implementation makes their compensation higher. Our results, based on both the level of compensation and the sensitivity of compensation to firm-specific and industry-wide performance, suggest CEOs are shielded from the worst performance outcomes, and rewarded through either RPE or PFL when one or the other leads to increased compensation. CEOs do not double-dip, however; compensation does not increase further when both RPE and PFL are in their favor. Our evidence shows that these compensation patterns are even stronger when firms have strong corporate governance mechanisms in place, consistent with optimal contracting between firms and CEOs and not with CEO manipulation of the pay process to expropriate wealth from the shareholders. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Review of Quantitative Finance and Accounting Springer Journals

Relative performance evaluation, pay-for-luck, and double-dipping in CEO compensation

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Publisher
Springer US
Copyright
Copyright © 2013 by Springer Science+Business Media New York
Subject
Economics / Management Science; Finance/Investment/Banking; Accounting/Auditing; Econometrics; Operations Research/Decision Theory
ISSN
0924-865X
eISSN
1573-7179
D.O.I.
10.1007/s11156-013-0423-3
Publisher site
See Article on Publisher Site

Abstract

We investigate whether chief executive officer (CEO) pay is linked to firm-specific and/or industry-wide performance only when it results in higher compensation. We argue CEOs have incentives to influence the ex post implementation of both relative performance evaluation (RPE) and pay-for-luck (PFL). Specifically, CEOs prefer RPE only when they outperform their reference group regardless of industry performance. Similarly, CEOs prefer PFL only when industry conditions are favorable. CEOs will try, ex post, to influence compensation committees to implement RPE and/or PFL only when implementation makes their compensation higher. Our results, based on both the level of compensation and the sensitivity of compensation to firm-specific and industry-wide performance, suggest CEOs are shielded from the worst performance outcomes, and rewarded through either RPE or PFL when one or the other leads to increased compensation. CEOs do not double-dip, however; compensation does not increase further when both RPE and PFL are in their favor. Our evidence shows that these compensation patterns are even stronger when firms have strong corporate governance mechanisms in place, consistent with optimal contracting between firms and CEOs and not with CEO manipulation of the pay process to expropriate wealth from the shareholders.

Journal

Review of Quantitative Finance and AccountingSpringer Journals

Published: Dec 14, 2013

References

  • The role of boards of directors in corporate governance: a conceptual framework and survey
    Adams, RB; Hermalin, BE; Weishbach, MS
  • Peer firms in relative performance evaluation
    Albuquerque, AM

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