Generalist versus Specialist CEOs: The Impact of CEO Expertise on the Design of Compensation Contract
60 Pages Posted: 3 Jan 2019 Last revised: 21 Jan 2020
Date Written: November 28, 2018
Generalist CEOs receive higher pay than specialist CEOs. We examine the implications of CEO expertise for the structure of executive compensation. We follow contract theory and predict that information asymmetry induces generalist CEOs to overstate their ability to a larger extent when contracting with shareholders. Board of directors takes it into account by designing a compensation contract that links their pay more closely to firm performance. Our empirical results support this prediction, and the link is more pronounced when generalist CEOs are less known in the executive labor market or are externally hired. The results hold after we control for a battery of factors that potentially impact incentive pay, including firm characteristics and CEO ability. The endogeneity concern is mitigated through estimations based on instrumental variables and propensity score matching. Alternative explanations such as risk-taking and price efficiency are unlikely to account for our findings. We also discuss the impact of moral hazard on our findings. Overall, our results support the optimal contracting perspective of executive compensation and highlight the importance of CEO expertise generality in resolving adverse selection during the contracting process.
Keywords: Compensation Contract; CEO Expertise; Generalists; Information Asymmetry
JEL Classification: G34, J24, J33
Suggested Citation: Suggested Citation