Wealth Shocks and Executive Compensation: Evidence from CEO Divorce
The University of Melbourne; Financial Research Network (FIRN)
September 3, 2012
To empirically test the impact of CEOs’ outside wealth on their compensation, I use spousal divorce as a proxy for a negative shock to a CEO’s outside wealth. I predict that this shock decreases a CEO's risk tolerance and that the board of directors adjusts the CEO's compensation incentives in response to the change in wealth incentives. I find that cash bonuses, restricted stock grants, and option grants increase following CEO divorce, suggesting boards react to changes in CEOs' outside wealth and risk incentives. I also find lower equity risk, idiosyncratic risk, and cash flow risk during the year of a CEO’s divorce, consistent with lower risk tolerance. I find no support for alternative explanations of the observed compensation increases: There is no evidence that CEOs delay compensation to the years following divorce. Lower risk does not result from CEOs from being 'distracted' by the divorce. Higher compensation following divorce is not driven by selection bias. In addition, the results are not driven by firm governance, CEO effort, or other variables related to the probability of divorce. Overall, compensation increases suggest the board of directors provides greater risk-taking incentives following a loss of wealth.
Number of Pages in PDF File: 47
Date posted: September 3, 2012
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