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

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  • Oscar Mitnik

    ()
    (Department of Economics, University of Miami)

  • Qiang Kang

    ()
    (Department of Finance, University of Miami)

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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Bibliographic 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:
Publication status: Forthcoming: Working Paper
Handle: RePEc:mia:wpaper:0906

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

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References

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  1. Rajesh Aggarwal & Andrew A. Samwick, 1998. "The Other Side of the Tradeoff: The Impact of Risk on Executive Compensation," NBER Working Papers 6634, National Bureau of Economic Research, Inc.
  2. Lucian Arye Bebchuk & Jesse M. Fried, 2003. "Executive Compensation as an Agency Problem," NBER Working Papers 9813, National Bureau of Economic Research, Inc.
  3. Kaplan, Steven N. & Minton, Bernadette A., 2006. "How Has CEO Turnover Changed? Increasingly Performance Sensitive Boards and Increasingly Uneasy CEOs," Working Paper Series 2006-7, Ohio State University, Charles A. Dice Center for Research in Financial Economics.
  4. Abadie, Alberto & Imbens, Guido W., 2011. "Bias-Corrected Matching Estimators for Average Treatment Effects," Journal of Business & Economic Statistics, American Statistical Association, vol. 29(1), pages 1-11.
  5. Gilson, Stuart C., 1989. "Management turnover and financial distress," Journal of Financial Economics, Elsevier, vol. 25(2), pages 241-262, December.
  6. 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.
  7. Jorge Aseff & Manuel Santos, 2005. "Stock options and managerial optimal contracts," Economic Theory, Springer, vol. 26(4), pages 813-837, November.
  8. Bebchuk, Lucian A. & Fried, Jesse M., 2003. "Executive Compensation as an Agency Problem," Berkeley Olin Program in Law & Economics, Working Paper Series qt81q3136r, Berkeley Olin Program in Law & Economics.
  9. M. P. Narayanan & H. Nejat Seyhun, 2008. "The Dating Game: Do Managers Designate Option Grant Dates to Increase their Compensation?," Review of Financial Studies, Society for Financial Studies, vol. 21(5), pages 1907-1945, September.
  10. James J. Heckman, 1989. "Choosing Among Alternative Nonexperimental Methods for Estimating the Impact of Social Programs: The Case of Manpower Training," NBER Working Papers 2861, National Bureau of Economic Research, Inc.
  11. Imbens, Guido & Abadie, Alberto, 2008. "On the Failure of the Bootstrap for Matching Estimators," Scholarly Articles 3043415, Harvard University Department of Economics.
  12. 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.
  13. 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.
  14. 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.
  15. 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.
  16. Jenter, Dirk & Kanaan, Fadi, 2008. "CEO Turnover and Relative Performance Evaluation," Research Papers 1992, Stanford University, Graduate School of Business.
  17. 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.
  18. Lucian Bebchuk & Yaniv Grinstein, 2005. "The Growth of Executive Pay," NBER Working Papers 11443, National Bureau of Economic Research, Inc.
  19. 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.
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