Hedge Fund Activist Entry and CEO Compensation

Abstract

Applying a difference-in-differences approach, we document the effect of hedge fund activism on the corporate governance of target firms through the channel of CEO compensation. We hand-collect data on managerial pay for a sample of 244 U.S. publicly-listed firms that were targets of activist hedge funds from 2009 to 2011, and their corresponding 244 industry, size and book-to-market matches. We find that target CEOs receive higher stock and total compensation, as compared to their peers, prior to an activist's entry. The entry of hedge fund activists results in a decline in target CEO pay to levels prevalent at matched firms. This decrease is not because target CEOs are extracting rents before activism, since CEO pay at target firms prior to activism is sensitive to firm performance. Instead, we show that the entry of hedge fund activists results in a decline in the pay-for-performance sensitivity of CEO stock awards and total pay at target firms. Our findings suggest that incentive compensation and monitoring by activist hedge funds act as substitutes in motivating CEOs to improve firm value.