HomeSeminar in Finance, Management Compensation, Summer 2008
Management Compensation
Seminar requirements
Write a paper (15-20 pages) and present it as a team. Papers can
be written in either German or English. The seminar talks should be
given in English.
Organisational matters
Where? Seminar in Hirschegg, Kleinwalsertal, Austria.
When? Seminar presentations will take place en bloc from 26th to 28th June 2008.
Submission of papers? Please hand in or send your final version of the paper to your supervisor until Friday, 20th of June. Ideally, you also send in your presentation before the seminar.
Hints for seminar work? Guidelines
Topics
For each topic, you should provide a literature survey (here you should consider more than the intro-paper).
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Compensation types and the valuation of executive options
How is the typical compensation package of top executives structured? Stock options account for a major part of it, but how can they be properly valued?
Intro-paper: Ammann, Seiz: "Valuing employee stock options: does the model matter?", 2004, Financial Analysts Journal
Supervisor: Jürgen Bohrmann
Students: Svetlana Karp & Julia Belovolova -
Optimal structure of executive compensation
The authors calibrate the standard principal–agent model with constant relative risk aversion and lognormal stock prices to a sample of 598 US CEOs. They show that this model predicts that most CEOs should not hold any stock options. Instead, CEOs should have lower base salaries and receive additional shares in their companies; many would be required to purchase additional stock in their companies. These contracts would reduce average compensation costs by 20% while providing the same incentives and the same utility to CEOs.
Intro-paper: Dittmann, Maug: "Lower salaries and no options? On the optimal structure of executive pay", 2007, Journal of Finance
Supervisor: Alina Maurer
Students: Matthias Böhm & Thomas Petretti -
Lack of relative performance evaluation
Although agency theory suggests that firms should index executive compensation to remove market-wide effects (i.e., RPE), there is little evidence to support this theory. Oyer (2004) posits that an absence of RPE is optimal if the CEO’s reservation wages from outside employment opportunities vary with the economy’s fortunes. The authors directly test and find support for Oyer’s (2004) theory. The authors argue that the CEO’s outside opportunities depend on his talent, as proxied by the CEO’s financial press visibility and his firm’s industry-adjusted ROA. The authors' results are robust to alternate explanations such as managerial skimming, oligopoly, and asymmetric benchmarking.
Intro-paper:
Rajgopal, Shevlin, Zamora: "CEOs' outside employment opportunities and the lack of relative performance evaluation in compensation contracts", 2006, Journal of Finance
Supervisor: Jürgen Bohrmann
Students: Lina Rusyte & Ksenia Malakova -
Golden handshakes
A golden handshake is a clause in an executive employment contract that provides the executive with a significant severance package in the case that the executive loses his or her job through firing, restructuring, or even scheduled retirement. This can be in the form of cash, equity, and other benefits, and is often accompanied by an accelerated vesting of stock options. The golden handshakes use has caused some investors concern since they do not specify that the executive had to perform well.
Intro-paper: Yermack: "Golden handshakes: separation pay for retired and dismissed CEOS", 2005, Journal of Accounting and Economics
Supervisor: Thomas Verchow
Students: Christoph Hirt & Björn Bitzer -
How compensation affects risk-taking and business decisions
In the first paper, the authors explore how compensation policies following mergers affect a CEO’s incentives to pursue a merger. The authors find that even in mergers where bidding shareholders are worse off, bidding CEOs are better off three quarters of the time. Following a merger, a CEO’s pay and overall wealth become insensitive to negative stock performance, but a CEO’s wealth rises in step with positive stock performance. Corporate governance matters; bidding firms with stronger boards retain the sensitivity of their CEOs’ compensation to poor performance following the merger. In comparison, we find that CEOs are not rewarded for undertaking major capital expenditures. In the second paper, the authors examine the relation between bidder returns and the probability of CEO turnover in acquiring firms. Using a sample of 714 acquisitions during 1990 to 1998, the authors find that 47% of CEOs of acquiring firms are replaced within 5 years, including 27% by internal governance, 16% by takeovers, and 4% by bankruptcy. A significant inverse relation exists between bidder returns and the likelihood of CEO turnover. This relation is not associated with governance structure. It also is not significantly different in stock versus cash acquisition. The third paper describes how traditional executive stock option plans allow fixed numbers of options to vest periodically, independent of stock price performance. Because such options may climb deep in-the-money long before the manager can exercise them, they can exacerbate risk aversion in project selection.
Intro-paper 1: Harford, Li: "Decoupling CEO wealth and firm performance: the case of acquiring CEOs", 2007, Journal of Finance
Intro-paper 2: Lehn, Zhao: "CEO turnover after acquisitions: are bad bidders fired?", 2006, Journal of Finance
Intro-paper 3: Brisley: "Executive stock options: early exercise provisions and risk-taking incentives", 2006, Journal of Finance
Intro-paper 4: Dow, Raposo: "CEO compensation, change, and corporate strategy", 2005, Journal of Finance
Supervisor: Jürgen Bohrmann
Students: Sophie Fux & Jiaqinq Lu, Jiang Shuang & Han Bao
Remark: Topic will be split up between the two teams. Proposal: Sophie Fux & Jiaqinq Lu work on the merger's and acquisitions' part (intro-paper 1 & 2); Jiang Shuang & Han Bao work on the general risk-taking part (intro-paper 3 & 4). -
What can we learn from the compensation of non-executives?
The authors consider how much of the top end of the income distribution can be attributed to four sectors – top executives of non-financial firms (Main Street); financial service sector employees from investment banks, hedge funds, private equity funds, and mutual funds (Wall Street); corporate lawyers; and professional athletes and celebrities. Non-financial public company CEOs and top executives do not represent more than 6.5% of any of the top AGI brackets (the top 0.1%, 0.01%, 0.001%, and 0.0001%). Individuals in the Wall Street category comprise at least as high a percentage of the top AGI brackets as non-financial executives of public companies. While the representation of top executives in the top AGI brackets has increased from 1994 to 2004, the representation of Wall Street has likely increased even more. While the groups studied here represent a substantial portion of the top income groups, they miss a large number of high-earning individuals. The authors conclude by considering how their results inform different explanations for the increased skewness at the top end of the distribution. The authors argue the evidence is most consistent with theories of superstars, skill biased technological change, greater scale and their interaction.
Intro-paper 1: Kaplan, Rauh: "Wall Street and Main Street: what contributes to the rise in the highest incomes?", 2007, working paper
Intro-paper 2: Faulkender, Yang: "Inside the black box: the role and composition of compensation peer groups", 2007, working paper
Supervisor: Gunter Löffler
Students: Sandra Kampmann & David Dornsaft -
What can we learn from historical trends and cross-country differences?
The first paper analyzes the long-run trends in executive compensation using a panel dataset of top executives in large firms from 1936 to 2005. In sharp contrast to the well-known steep upward trajectory of pay of the past 30 years, the median real value of compensation was remarkably flat from the late 1940s to the mid-1970s, highlighting a weak relationship between compensation and aggregate firm size. While this correlation has changed considerably over the century, the cross-sectional relationship between pay and firm size has remained stable. Another surprising finding is that the sensitivity of changes in an executive’s wealth to firm performance was not inconsequentially small for most of the sample period. Thus, recent years were not the first time when compensation arrangements served to align managerial incentives with those of shareholders. Overall, these trends pose a challenge to several common explanations for the recent surge in executive pay. The second paper examines the time-series and cross-sectional variation in the structure of managerial compensation contracts. The authors document significant cross-country differences in compensation structure (i.e., relative use of equity-based and cash-based compensation). The primary determinants of this cross-sectional variation are institutional factors related to the strength of shareholder rights and the quality of law enforcement in each country. Finally, despite the increasing globalization of financial markets, the compensation structures of US and non-US firms generally remain very different throughout the 1996-2004 period.
Intro-paper 1: Frydman, Saks: "Executive Compensation: a new view from long-term perspective, 1936-2005", 2007, working paper
Intro-paper 2: Bebchuk, Grinstein: "The growth of executive pay", 2005, Oxford Review of Economic Policy, Vol. 21
Intro-paper 3: Bryan, Nash, Patel: "The structure of executive compensation: international evidence from 1996-2004", 2005, working paper
Intro-paper 4: Elston, Goldberg: "Executive compensation and agency costs in Germany", 2001, Journal of Banking and Finance
Supervisor: Alina Maurer
Students: Kathleen Hempe & Eugene Muluka, Peter Härle & Konrad Embacher
Remark: Topic will be split up between the two teams. Proposal: Kathleen Hempe & Eugene Muluka work on the historical trends (intro-paper 1 & 2); Peter Härle & Konrad Embacher work on cross-country differences (intro-paper 3 & 4). -
How the money is spent: Perquisites and conspicuous consumption
The intro-paper studies perquisites of major company CEOs, focusing on personal use of company planes. For firms that have disclosed this managerial benefit, average shareholder returns under-perform market benchmarks by more than 4 percent annually, a severe gap far exceeding the costs of resources consumed.
Intro-paper: Yermack: "Flights of fancy: corporate jets, CEO perquisites, and inferior shareholder returns", 2005, AFA 2005 Philadelphia Meetings
Supervisor: Thomas Verchow
Students: Elisabeth Skorna & Bonaventura Konrad -
Is executive compensation too high?
Do stock market prices reflect the respective level of executive compensation? Or, in other words: Why are top executives of U.S. corporations paid so much? The 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, the author constructs 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. The author studies the effect of excess pay on the profitability of corporate acquisitions and the related choice of financing method. He finds 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.
Intro-paper 1: Falato: "Superstars or superlemons? Top executive pay and corporate acquisitions", 2006, working paper
Intro-paper 2: Bebchuk, Cremers, Peyer: "CEO centrality", 2007, Harvard Law School Olin Discussion Paper No. 601
Supervisor: Jürgen Bohrmann
Students: Shuonan Yuan & Christian de la Torre, Niko Saßhoff & Haidong Fan
Remark: Topic will be split up between the two teams. Proposal: Shuonan Yuan & Christian de la Torre work on the question, whether executives are paid so much due to their talent or due to their power (intro-paper 1). Niko Saßhoff & Haidong Fan also work on the question, why executives are paid so much, but with a stronger focus on a potential lack of corporate governance systems (intro-paper 2). -
Should shareholders have a say on executive compensation?
A new bill in the US requires an advisory shareholder vote on executive compensation packages. Using the abnormal return of 1,245 firms surrounding the passage of this bill, the authors examine whether the market interprets shareholders' say on executive pay as adding or subtracting firm value.
Intro-paper: Cai, Walkling: "Shareholders' say on pay: does it create value?", 2007, working paper
Supervisor: Gunter Löffler
Students: Halidu Gibrilla & Elke Gerstmayr -
Executive pension arrangements
What kind of executive pensions arrangements exist and what is the role of inside debt?
Intro-paper: Sundaram, Yermack: "Pay me later: inside debt and its role in managerial compensation", 2007, Journal of Finance
Supervisor: Jürgen Bohrmann
Students: Beili Huang