Managerial Power, Stock-Based Compensation, and Firm Performance: Theory and Evidence

Abstract:     
This paper has two main objectives. First, we provide a simple, theoretical analysis of how managerial power affects CEO compensation and firm performance. Our theoretical model follows the rent extraction view of CEO compensation put forward by the managerial power theory. To focus on the main thesis of the managerial power theory, we restrict our attention to one aspect of power, namely the CEO's power to influence his own pay.

Second, we provide empirical analyses of our theoretical findings in a unified framework using a comprehensive data set encompassing CEO power, CEO pay, and firm performance. Our theoretical predictions on the relation between CEO power and CEO pay, and the relation between CEO power and pay-performance sensitivity of CEO's stock-base compensation are largely supported by our empirical findings for diverse measures of CEO power. However the predicted relation between CEO power and firm performance has mixed support: for some measures of CEO power and firm performance, more CEO power is shown to be detrimental to outside shareholders; for other measures, more CEO power is shown to improve return to outside shareholders. This suggests that, while the managerial power theory has clear relevance in explaining the relation between power and pay, the scope of power needs to be broadened to have better understanding of how CEO power affects firm performance.

Number of Pages in PDF File: 57

Keywords: Managerial power, agency theory, stock-based compensation, performance

JEL Classification: D82, G32, J33

working papers series