What matters most in CEO compensation?

Abstract

Components of compensation have been analysed in previous studies of corporate financial variables of interest but never together to get a sense of the complete picture of what truly matters. This paper includes variable interactions using the difference-in-differences methodology for panel regressions. Data is collected from Capital IQ, Compustat, CRSP, and ExecuComp for S&P 1500 firms from 2006 to 2013. Inside debt is negatively related to a firm’s total risk, idiosyncratic risk, and CEO turnover. Inside debt is positively related to diversification, liquidity, firm value, and return. Overconfidence is negatively related to total risk, liquidity, investment, and firm value. The CEO pay slice is positively related to total risk but negatively related to diversification, liquidity, and firm value. Interactions among these variables lead to an increase in total risk but a decrease in investment, diversification, liquidity, and firm value. Inside debt mitigates CEO risky decision making, whereas CEOs who are overconfident by their option exercise behaviour or their relative compensation to other directors creates a situation where they are encouraged to take on more risk, which, on average, is shown to harm the firm.