Outside Opportunities, Managerial Risk Preferences, and CEO Compensation
The Accounting Review, forthcoming. https://doi.org/10.2308/TAR-2018-0614
55 Pages Posted: 28 Nov 2017 Last revised: 15 Jun 2021
Date Written: March 23, 2021
Abstract
Exploiting the setting of staggered adoption of the Inevitable Disclosure Doctrine (IDD) in U.S. state courts, we examine how quasi-exogenous restrictions of outside employment opportunities affect CEO compensation structure. The IDD adoption constrains executives’ ability to work for competitors, which likely decreases CEOs’ tendency to take risks by increasing the cost of job loss and reducing the reward to risk taking. We expect the board to respond by increasing the sensitivity of CEO wealth to stock volatility (vega) to encourage risk taking. We find a significant increase in vega post-IDD adoption. The effect is stronger among CEOs with greater career concerns. The effect also increases with the ex-ante CEO mobility and the importance of trade secrets, suggesting that the board increases vega more when there is a greater reduction in CEO outside opportunities. Overall, we provide new evidence on how external labor market frictions affect the convexity of CEO compensation.
Keywords: External labor market, Inevitable disclosure doctrine, CEO compensation, Risk-taking incentives
JEL Classification: G32, M12, J60
Suggested Citation: Suggested Citation