Opacity and Executive Compensation
47 Pages Posted: 2 Nov 2010 Last revised: 25 Oct 2015
Date Written: September 12, 2008
We develop and test the hypothesis that firms´ 'opacity induces increased risk sharing by managers, in particular by taking more risk in executive compensation contracts. We test this hypothesis in a manner robust to errors-in-variables bias and reverse-causality by using institutional trading as an instrument for 'opacity. Consistent with the hypothesis, we find a positive relation between pay-performance sensitivity and measures of the opacity of financial reporting and stock prices. Our findings suggest that institutional trading can act as a substitute for risky executive compensation by limiting opacity.
Keywords: Arbitrage, Institutional investors, Executive compensation, Corporate governance, Information content of stock prices
JEL Classification: M41, M47, J33, G32, D82
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