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Not So Lucky Any More: CEO Compensation in Financially Distressed Firms

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Author Info
Oscar Mitnik () (Department of Economics, University of Miami)
Qiang Kang () (Department of Finance, University of Miami)

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Abstract

There is a debate on whether executive pay reflects rent extraction due to “managerial power†or is the result of arms-length bargaining in a principal-agent framework. In this paper we offer a test of the managerial power hypothesis by empirically examining the CEO compensation of U.S. public companies that were ever in financial distress between 1992 and 2005. Using a bias-corrected matching estimator that estimates the causal effects of financial distress, we find that, for the distressed firms, CEO turnover rates increase markedly and their CEOs, both incumbents and successors, experience significant reductions in total compensation. The bulk of the reduction in total compensation derives from the decline in value of stock option grants, which we argue is due to a change in the opportunistic timing of option grants. We define “lucky†grants as those with grant prices below or at the lowest stock price of the grant month, and we find that the proportion of lucky grants for financially distressed firms is higher before insolvency and lower upon and after insolvency, while the proportion for similar but solvent firms remains stable throughout the period. We interpret this evidence as consistent with a decrease in managerial power induced by a tightening in the “outrage†constraint due to the episode of financial distress.

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File URL: http://www.bus.miami.edu/_assets/files/faculty-and-research/academic-departments/eco/eco-working-papers/wp2009-06-CEO_Comp_distress.pdf
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Publisher Info
Paper provided by University of Miami, Department of Economics in its series Working Papers with number 0906.

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Length: 41 pages
Date of creation: Nov 2008
Date of revision:
Handle: RePEc:mia:wpaper:0906

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Related research
Keywords: CEO compensation; CEO turnover; financial distress; lucky grants; bias-corrected matching estimators;

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Find related papers by JEL classification:
G30 - Financial Economics - - Corporate Finance and Governance - - - General
J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods
M52 - Business Administration and Business Economics; Marketing; Accounting - - Personnel Economics - - - Compensation and Compensation Methods and Their Effects

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  1. Steven N. Kaplan & Bernadette Minton, 2006. "How has CEO Turnover Changed? Increasingly Performance Sensitive Boards and Increasingly Uneasy CEOs," NBER Working Papers 12465, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  2. Lucian Bebchuk & Yaniv Grinstein, 2005. "The Growth of Executive Pay," NBER Working Papers 11443, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  3. Heckman, J.J. & Hotz, V.J., 1988. "Choosing Among Alternative Nonexperimental Methods For Estimating The Impact Of Social Programs: The Case Of Manpower Training," University of Chicago - Economics Research Center 88-12, Chicago - Economics Research Center.
    Other versions:
  4. Bebchuk, Lucian Arye & Fried, Jesse, 2003. "Executive Compensation as an Agency Problem," CEPR Discussion Papers 3961, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  5. Lucian Bebchuk & Jesse Fried, 2003. "Executive Compensation as an Agency Problem," Berkeley Olin Program in Law & Economics, Working Paper Series 1106, Berkeley Olin Program in Law & Economics. [Downloadable!]
  6. Warner, Jerold B. & Watts, Ross L. & Wruck, Karen H., 1988. "Stock prices and top management changes," Journal of Financial Economics, Elsevier, vol. 20(1-2), pages 461-492, January. [Downloadable!] (restricted)
  7. Marianne Bertrand & Sendhil Mullainathan, 2001. "Are Ceos Rewarded For Luck? The Ones Without Principals Are," The Quarterly Journal of Economics, MIT Press, vol. 116(3), pages 901-932, August. [Downloadable!] (restricted)
  8. Gilson, Stuart C., 1989. "Management turnover and financial distress," Journal of Financial Economics, Elsevier, vol. 25(2), pages 241-262, December. [Downloadable!] (restricted)
  9. Dirk Jenter & Fadi Kanaan, 2006. "CEO Turnover and Relative Performance Evaluation," NBER Working Papers 12068, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  10. Rajesh K. Aggarwal & Andrew A. Samwick, 1999. "The Other Side of the Trade-off: The Impact of Risk on Executive Compensation," Journal of Political Economy, University of Chicago Press, vol. 107(1), pages 65-105, February. [Downloadable!] (restricted)
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  11. Haubrich, Joseph G, 1994. "Risk Aversion, Performance Pay, and the Principal-Agent Problem," Journal of Political Economy, University of Chicago Press, vol. 102(2), pages 258-76, April. [Downloadable!] (restricted)
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  12. M. P. Narayanan & H. Nejat Seyhun, 2008. "The Dating Game: Do Managers Designate Option Grant Dates to Increase their Compensation?," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 21(5), pages 1907-1945, September. [Downloadable!] (restricted)
  13. Jorge Aseff & Manuel Santos, 2005. "Stock options and managerial optimal contracts," Economic Theory, Springer, vol. 26(4), pages 813-837, November. [Downloadable!] (restricted)
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  14. Garvey, Gerald T. & Milbourn, Todd T., 2006. "Asymmetric benchmarking in compensation: Executives are rewarded for good luck but not penalized for bad," Journal of Financial Economics, Elsevier, vol. 82(1), pages 197-225, October. [Downloadable!] (restricted)
  15. Alberto Abadie & Guido W. Imbens, 2006. "Large Sample Properties of Matching Estimators for Average Treatment Effects," Econometrica, Econometric Society, vol. 74(1), pages 235-267, 01. [Downloadable!] (restricted)
  16. Alberto Abadie & David Drukker & Jane Leber Herr & Guido W. Imbens, 2004. "Implementing matching estimators for average treatment effects in Stata," Stata Journal, StataCorp LP, vol. 4(3), pages 290-311, September. [Downloadable!]
  17. Alberto Abadie & Guido W. Imbens, 2008. "On the Failure of the Bootstrap for Matching Estimators," Econometrica, Econometric Society, vol. 76(6), pages 1537-1557, November. [Downloadable!] (restricted)
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  18. Lucian Arye Bebchuk & Jesse M. Fried, 2003. "Executive Compensation as an Agency Problem," NBER Working Papers 9813, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  19. Lucian Arye Bebchuk & Jesse M. Fried, 2003. "Executive Compensation as an Agency Problem," Journal of Economic Perspectives, American Economic Association, vol. 17(3), pages 71-92, Summer. [Downloadable!] (restricted)
  20. Gilson, Stuart C & Vetsuypens, Michael R, 1993. " CEO Compensation in Financially Distressed Firms: An Empirical Analysis," Journal of Finance, American Finance Association, vol. 48(2), pages 425-58, June. [Downloadable!] (restricted)
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