Why Do CEOS Increase Their Equity-Based Compensation? Because They Have to

42 Pages Posted: 15 Mar 2006

See all articles by Nishant Dass

Nishant Dass

Georgia Institute of Technology - Scheller College of Business

Massimo Massa

INSEAD - Finance

Urs Peyer

INSEAD - Finance

Date Written: November 2005

Abstract

We study whether firms tend to make the compensation of their managers dependent on the relative level of valuation. We consider compensation in the sample period between 1992 and 2003 and show that an increase in company valuation leads to an increase in the pay-for-performance sensitivity. This is rejecting the hypothesis that managers skim the company by setting their own compensation in a way consistent with the market timing theory. However our findings are consistent with the interpretation that this increase in the pay-for-performance sensitivity and increase in equity-based compensation is a way for effective boards to incentivize CEOs in the light of uncertainty whether the high valuation is due to the ability of the managers or due to luck. We find that firms with better governance are more likely to make their managers' compensation more sensitive to performance if the firm displays a high market-to-book ratio relative to its past or relative to the industry. We also find that firms which increase the compensation of their managers experience a price decrease in the following months, suggesting that the board is successfully timing the market or that their doubts about the high market-to-book ratio being due to skill was justified.

Keywords: Executive Compensation, Corporate Governance

JEL Classification: G39, G34

Suggested Citation

Dass, Nishant and Massa, Massimo and Peyer, Urs C., Why Do CEOS Increase Their Equity-Based Compensation? Because They Have to (November 2005). AFA 2007 Chicago Meetings Paper. Available at SSRN: https://ssrn.com/abstract=891059 or http://dx.doi.org/10.2139/ssrn.891059

Nishant Dass (Contact Author)

Georgia Institute of Technology - Scheller College of Business ( email )

800 West Peachtree St.
Atlanta, GA 30308
United States
404-894-5109 (Phone)

HOME PAGE: http://scheller.gatech.edu/dass

Massimo Massa

INSEAD - Finance ( email )

Boulevard de Constance
F-77305 Fontainebleau Cedex
France
+33 1 6072 4481 (Phone)
+33 1 6072 4045 (Fax)

Urs C. Peyer

INSEAD - Finance ( email )

Boulevard de Constance
F-77305 Fontainebleau Cedex
France
+33 1 6072 4178 (Phone)
+33 1 6072 4045 (Fax)

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