The Role of Stock Liquidity in Executive Compensation

The Accounting Review, Forthcoming

42 Pages Posted: 25 Sep 2009 Last revised: 24 Jul 2011

See all articles by Sudarshan Jayaraman

Sudarshan Jayaraman

University of Rochester - Simon Business School; Simon Business School, University of Rochester

Todd T. Milbourn

Washington University in Saint Louis - Olin Business School

Date Written: July 22, 2011

Abstract

We explore the role of stock liquidity in influencing the composition of CEO annual pay and the sensitivity of managerial wealth to stock prices. We find that as stock liquidity goes up, the proportion of equity-based compensation in total compensation increases while the proportion of cash-based compensation declines. Further, the CEO’s pay-for-performance sensitivity with respect to stock prices is increasing in the liquidity of the stock. Our main findings are supported by additional tests based on shocks to stock liquidity and two-stage-least squares specifications that mitigate endogeneity concerns. Our results are consistent with optimal contracting theories and contribute to the ongoing debate about the increasing trend of both equity-based over cash-based compensation and the sensitivity of total CEO wealth to stock prices rather than earnings.

Keywords: Compensation, stock liquidity, stock price informativeness, optimal contracting, pay for performance

JEL Classification: G12, M46, J33

Suggested Citation

Jayaraman, Sudarshan and Jayaraman, Sudarshan and Milbourn, Todd T., The Role of Stock Liquidity in Executive Compensation (July 22, 2011). The Accounting Review, Forthcoming, Available at SSRN: https://ssrn.com/abstract=1477620

Sudarshan Jayaraman (Contact Author)

University of Rochester - Simon Business School ( email )

Rochester, NY 14627
United States
585-275-3491 (Phone)

Simon Business School, University of Rochester ( email )

Rochester, NY 14627
United States
585-275-3491 (Phone)

Todd T. Milbourn

Washington University in Saint Louis - Olin Business School ( email )

1 Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States
314-935-6392 (Phone)
314-935-6359 (Fax)

HOME PAGE: http://www.olin.wustl.edu/faculty/milbourn/

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