Morse et al. (2011), henceforth MNS, interpret the data to suggest that more powerful CEOs ex post change their incentive contracts to put greater weight on performance measures that are ex-post more favorable. My paper points out a number of issues with their inference. First and most importantly, MNS do not control for the fact that not just the most powerful but almost all firms change their incentive contracts ex post. This is also consistent with an optimal contracting model. Nevertheless, the MNS specification attributes all explanatory power of the average incentive realignment to the cross-coefficient; that is, to more powerful CEOs. When the average level of ex post contract change is also controlled for, the MNS cross-coefficient (the additional change attributed to more powerful CEOs) declines by 55% and becomes insignificant. Second, newly-hired CEOs often receive large one-time startup packages. These firms should be broken out, because the MNS theory is not about newly-hired CEOs as new CEOs could not have rigged a previously-set compensation. Third, the results are sensitive to how industry performance is adjusted for. Fourth, the results are sensitive to the level of winsorization.
Incentive Contracts are not Rigged by Powerful CEOs* Available to Purchase
* I appreciate Adair Morse, Vikram Nanda, and Amit Seru for generously sharing certain of their data used in Morse et al. (2011), and for commenting on my paper. I am particularly grateful to Ivo Welch (the editor) and an anonymous referee for their constructive and insightful comments. I also thank Nina Baranchuk, John Bizjak, Harold Demsetz, John Graham, Cam Harvey, Wai-Tung Ho, Jun-Koo Kang, Jonathan Karpoff, Benjamin Klein, Ken Lehn, Mike Lemmon, Kevin J. Murphy, Daniel Rogers, James Smith, Avanidhar Subrahmanyam, Wing Suen, Jim Vere, Frances Xu, Yexiao Xu, Harold Zhang, and seminar participants at the Hong Kong Polytechnic University, University of Hong Kong, the 2012 PolyU Summer Research Camp in Finance, the 2012 FMA Annual Meeting, the 2012 China International Conference in Finance, and the 2013 PolyU Mini Conference on Executive Compensation for their useful suggestions.
Wan K (2014), "Incentive Contracts are not Rigged by Powerful CEOs*". Critical Finance Review, Vol. 3 No. 1 pp. 99–152, doi: https://doi.org/10.1561/104.00000016
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