Implications of Economic Shocks for CEO Performance Evaluation

38 Pages Posted: 8 Mar 2015 Last revised: 15 Mar 2016

See all articles by Claudine Mangen

Claudine Mangen

Concordia University, Montreal - John Molson School of Business

Date Written: March 11, 2016

Abstract

I study the implications of economic shocks for objective and subjective CEO performance evaluation. I explore objective CEO performance evaluation using the sensitivity of CEO cash pay to earnings. To set this sensitivity, pay-setting parties draw on information about earnings, which is perturbed when a shock occurs: after the shock, pay-setting parties lack information about earnings and need to estimate post-shock earnings, which introduces estimation risk into earnings-based CEO cash pay. To mitigate the impact of estimation risk on risk-averse CEOs, pay-setting parties reduce the sensitivity of CEO cash pay to earnings immediately after a shock. Over time, pay-setting parties learn about post-shock earnings, and estimation risk declines; I predict that, as a result, the sensitivity of CEO cash pay to post-shock earnings rises. Using U.S. executive pay data between 1992 and 2013, I find support for this prediction and document that the sensitivity of CEO cash pay to earnings increases progressively after a shock occurs. I next explore subjective CEO performance evaluation using handcollected data from U.S. proxy statements. I document that firms rely more extensively on subjective performance evaluation for setting CEO cash pay right after a shock occurs. My results suggest that objective CEO performance evaluation is deemphasized right after a shock in favor of subjective CEO performance evaluation, only to be used more intensely again as time passes since the shock occurred.

Keywords: executive pay, economic shocks, learning, earnings, subjective performance evaluation

JEL Classification: M52, M41, G34, D83, E32

Suggested Citation

Mangen, Claudine, Implications of Economic Shocks for CEO Performance Evaluation (March 11, 2016). European Accounting Review Forthcoming, Available at SSRN: https://ssrn.com/abstract=2574872 or http://dx.doi.org/10.2139/ssrn.2574872

Claudine Mangen (Contact Author)

Concordia University, Montreal - John Molson School of Business ( email )

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Canada
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HOME PAGE: http://claudinemangen.com/

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