CEO Personal Wealth, Equity Incentives and Firm Performance

Abstract

Manuscript Type Empirical Research Question/Issue In this paper, we explore the determinants and performance effects of a novel measure of executive incentives, that is, the elasticity of a CEO's total wealth to firm performance, computed as a CEO's ownership value relative to her total wealth. Research Findings/Insights Using unique data on the total personal wealth of the CEOs of listed Swedish firms, we find that while CEOs typically own only a very small fraction of the shares of their firms, this ownership often constitutes a significant part of their total wealth. We also find that a CEO's total wealth elasticity is negatively associated with firm size and a CEO's age is positively associated with a firm risk environment. As for the effect on firm performance, we find that higher CEO's equity incentives enhance future accounting firm performance, when we estimate panel data regressions by taking into account the dynamic nature of endogeneity between a CEO's incentives and firm performance. However, we do not find any evidence that a CEO's equity incentives to be related to future stock returns. Theoretical/Academic Implications Our analysis suggests that executives' incentives when measured as price‐performance elasticity are economically more significant than has been often argued in the literature. Moreover, due to several advantages of price‐performance elasticity over traditionally used fractional ownership and dollar‐at‐stake measures, the inferences drawn from this study with respect to determinants and performance implications of a CEO's incentives may be superior to those from prior studies. The result on the relation between firm size and a CEO's incentives is especially interesting, because, unlike fractional ownership, the elasticity of a CEO's total wealth to firm performance is not spuriously related to firm size. With respect to the relation between incentives and subsequent firm performance, our results are consistent with the view that higher CEO's incentives, measured as price‐performance elasticity, enhance firm accounting performance. Overall, future studies should consider price‐performance elasticity as an alternative measure of executive incentives in addressing various research questions. Practitioner/Policy Implications The evidence in this paper suggests that executive incentives calculated relative to their non‐firm wealth are economically more meaningful if compared to the traditionally used measures. As such, compensation consultants and boards of directors can consider this alternative measure when designing executive compensation plans and determining an appropriate level of ownership, when the information on executive non‐firm wealth is available.

Executive Compensation, Corporate Governance and Corporate Performance: A Simultaneous Equation Approach

“…CEO age ranges from a minimum of 34 years to a maximum of 76 years with an average of 55 years. This supports previous evidence that CEOs, on average, tend to be matured and experienced individuals (Ozkan, ; Elsila et al ., ). Similarly, CEO tenure (CTENURE) ranges between a minimum of zero (less than 6 months) and maximum of 28 years with median tenure of 6 1/2 years, and thereby providing support for the similar findings of past studies (Ozkan, ; Bai and Elyasiani, ; Cook and Burress, ).…”

“…We note that whereas the absolute levels of top executive pay in SA are relatively lower than those reported in developed countries, such as the UK and US (Main et al ., ; Conyon and Murphy, ; Zheng, ; Ozkan, ; Cook and Burress, ; Elsila et al ., ; Kabir et al ., ), evidence of increasing levels of executive pay is generally consistent with their results. Noticeably, and despite King II's suggestion that equity should form a larger part of executives pay in order to align their interests with those of shareholders, total cash pay continue to form a substantial portion of total executive pay.…”

“…However, the recent global financial crisis precipitated by increased risk‐taking and pay motives of top executives of major banks (Tung, ; Aebi et al ., 2012; Paligorova, ; Lin et al ., ; Tang, ; Polat and Nisar, ; Wesep and Wang, ) has reignited the debate regarding the effectiveness of executive compensation packages in mitigating agency conflicts in modern corporations (Goering, ; Murphy, ; Grundy and Li, ; Van Essen et al ., ; Berger et al ., ; Cook and Burress, ). Although a number of papers have examined the link between executive pay and corporate performance, the general conclusion is that the link is weak (Murphy, ; Canarella and Nourayi, ; Dong et al ., ; Elsila et al ., ; Kabir et al ., ; Tian, 2013).…”

CEO's Total Wealth Characteristics and Implications on Firm Risk

“…Lambert et al ; Kahl et al ), data constraints tend to restrict empirical applications to poor proxies for managerial wealth. Exceptions include Becker (), who study executive compensation by using Swedish data on CEOs' total wealth (but not its decomposition); Dittman and Maug (), who proxy total wealth by a time series for all compensation received by the US executives in their study; and Elsilä et al (), who study the effect of the proportion of CEOs' investment in their own firm on future accounting performance. While the Elsilä et al () paper uses the decomposition of managers' wealth to investment in own firm, other stock holdings, and nonstock wealth, we are not aware of any prior studies utilizing complete data on CEOs' portfolio compositions, including complete data within the stock portfolio.…”

“…While all these recent studies shed light on the connection between managerial wealth and corporate risk‐taking, they focus only on parts of CEO wealth, as data restrictions have not allowed studying the effects of CEOs' total wealth. The rare exceptions to consider CEOs' total wealth include Becker (), who studies the effects of total wealth on performance‐based compensation among Swedish CEOs, and Elsilä et al (), who observe the connection between total wealth of Swedish CEOs and their firms' subsequent accounting performance.…”