CEO Compensation and Real Estate Prices: Pay for Luck or Pay for Action?
59 Pages Posted: 8 Aug 2018 Last revised: 26 Mar 2019
Date Written: February 28, 2019
This paper uses real estate price shocks to study the sensitivity of CEO pay to luck. Evidence that CEOs are paid for lucky events that are outside of their control is commonly interpreted as inefficient contracting. However, compensating CEOs for luck can be part of efficient contracting if boards want to provide CEOs with incentives to act or respond to the lucky event. We use real estate price shocks to test whether CEOs are paid for luck, or paid to act or respond to luck. We distinguish between pay for luck and pay for action by exploiting GAAP accounting rules. In the US real estate used in the firm's operations is not market-to-market, thus a change in the value of real estate is only accounted for when the CEO reacts to the change in property value by, for instance, selling the real estate asset. We show that CEO compensation is associated with responses to real estate luck, which mostly explains the pay for luck. Our results challenge the inefficient contracting interpretation of pay for luck.
Keywords: pay for luck; real estate prices; executive compensation
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