Efficient Contracting or Rent Seeking for Long-Tenured CEOs
52 Pages Posted: 14 Jan 2016
Date Written: January 14, 2016
Uncertainty about a CEO’s ability is related to his/her length of service to a firm. Accordingly, monitoring systems should vary depending upon CEOs’ tenure. Long-tenured CEOs require less monitoring because their ability has been revealed over time. However, as CEOs advance in their careers, they are more likely to acquire power to influence board decisions. To analyze this implication, I examine whether the competing rent-seeking or efficient contracting hypotheses can explain long-tenured executives’ disposal decisions. I use the previously reported differential sensitivity of CEO cash compensation to income-increasing and -decreasing discontinued operations. Contrary to prior findings, I find that cash compensation for long-tenured CEOs is positively associated with both income-decreasing and -increasing discontinued operations. These results suggest that compensation committees provide opportunities for them to demonstrate their abilities, and these executives are willing to swallow the one-time negative effect to improve future operating performance. Therefore, my results for long-tenured CEOs support the efficient contracting hypothesis. I also analyze whether market participants scrutinize CEOs’ disposal decisions, and find that they react favorably to managerial decisions on both income-increasing and -decreasing DCs, consistent with the notion that they view these DCs as value-enhancing activities. Lastly, the post-period analysis shows that income-decreasing DCs improve future firm performance, and there is no evidence that income-increasing DCs cause long-term detrimental effects. These findings are consistent with the notion that boards implement systems that force long-tenured CEOs to continue to demonstrate their ability to make value-enhancing decisions.
Keywords: Long-tenured CEO, Cash Compensation, Efficient contract, rent seeking
JEL Classification: M52 M41 J33
Suggested Citation: Suggested Citation