Managerial Attributes and Executive Compensation

Abstract

We study the role of manager-specific heterogeneity in explaining executive compensation. We decompose the variation in executive compensation into time variant and invariant firm and manager components and find that time invariant manager fixed effects explain a majority of the variation in executive pay. In addition, we show that including manager fixed effects alters coefficients and interpretations of other variables. We also find that firm performance improves after CEOs with larger compensation fixed effects are hired, which is consistent with the fixed effect being associated with innate managerial ability or social capital, which in turn leads to better performance. We further derive managers' excess compensation by purging time variant effects and firm, manager, and year fixed effects, and show that firms with over-paid managers use less debt, consistent with theoretical predictions.JEL Classification: G3, G32, J24, J31, J33, C23 Keywords: Executive compensation, CEO pay, latent managerial ability, human capital, fixed effects, manager fixed effects, capital structure Managerial Attributes and Executive Compensation AbstractWe study the role of manager-specific heterogeneity in explaining executive compensation. We decompose the variation in executive compensation into time variant and invariant firm and manager components and find that time invariant manager fixed effects explain a majority of the variation in executive pay. In addition, we show that including manager fixed effects alters coefficients and interpretations of other variables. We also find that firm performance improves after CEOs with larger compensation fixed effects are hired, which is consistent with the fixed effect being associated with innate managerial ability or social capital, which in turn leads to better performance. We further derive managers' excess compensation by purging time variant effects and firm, manager, and year fixed effects, and show that firms with over-paid managers use less debt, consistent with theoretical predictions.JEL Classification: G3, G32, J24, J31, J33, C23

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