Superstars or Superlemons? Top Executive Pay and Corporate Acquisitions

Abstract

Why are top executives of U.S. corporations paid so much? This paper evaluates empirically the merit of the two main existing answers to this question: 1) because of their talent; or 2) because of their power. To this end, I construct a simple measure of short-term excess pay of CEOs and other top executives, defined as the deviation of actual pay from the normal pay implied by firm, industry, and executive characteristics. I study the effect of excess pay on the profitability of corporate acquisitions and the related choice of financing method. I find that excess pay has a positive impact on shareholder value, in that acquirers who give excess rewards to their top executives experience significantly higher announcement-period abnormal stock returns than acquirers who do not. Moreover, excess pay decreases the likelihood that an acquisition is financed with equity. These results are strongly consistent with a model of executive pay based on talent rather than power.

Keywords: Executive Compensation, Acquirer Returns, Agency

JEL Classification: G30, G34