Three Essays on Executive Incentive Pay and Causal Inference in Corporate Finance
type: CreativeWork
description: Determinants of CEO Compensation and Firm Performance — A Survey Reviewing a large set of literature on CEO compensation and firm performance, I find the following. First, institutional and macro-level factors tend to take the first order importance in determining CEO compensation and firm outcome as well as many other factors in corpo- rate finance and corporate governance. Second, relations among the factors that determine CEO compensation and firm outcome are complex and often the exact causal directions are ambiguous. Third, endogeneity is present and it’s likely many factors including CEO compensation and firm performance are jointly determined. Fourth, CEO compensation has been mainly characterized in a principal-agent framework and many factors are regarded as either constraining or exacerbating the agency problems. Optimality of Dynamic CEO Compensation and the Endogeneity Problem Optimal dynamic contract theory postulates that the CEO’s portfolio needs to be rebal- anced each year to maintain the optimal incentive that implements a targeted effort. Thus, given previous year’s incentive, there exists an optimal adjustment that has to be made by the principal in order to maximize firm value. If contracts are optimally written and im- plemented, it’s expected that the derivative of firm value on changes in CEO incentive is zero. I test this hypothesis by estimating the treatment effect of changes in CEO incentive on firm value while controlling for a large set of lagged market, firm, board and CEO charac- teristics and using the inverse probability-of-treatment weighting method. I also use lagged firm policy variables as proxies for unobserved characteristics such as CEO risk aversion. Part of the results show that there is no significant effect of incentive adjustment on firm value, thus possibly confirming the optimality of CEO incentive contracts. However, there is also evidence that unobserved confoudning exists and the inherent endogeneity may bias the re…
abstract: Determinants of CEO Compensation and Firm Performance — A Survey Reviewing a large set of literature on CEO compensation and firm performance, I find the following. First, institutional and macro-level factors tend to take the first order importance in determining CEO compensation and firm outcome as well as many other factors in corpo- rate finance and corporate governance. Second, relations among the factors that determine CEO compensation and firm outcome are complex and often the exact causal directions are ambiguous. Third, endogeneity is present and it’s likely many factors including CEO compensation and firm performance are jointly determined. Fourth, CEO compensation has been mainly characterized in a principal-agent framework and many factors are regarded as either constraining or exacerbating the agency problems. Optimality of Dynamic CEO Compensation and the Endogeneity Problem Optimal dynamic contract theory postulates that the CEO’s portfolio needs to be rebal- anced each year to maintain the optimal incentive that implements a targeted effort. Thus, given previous year’s incentive, there exists an optimal adjustment that has to be made by the principal in order to maximize firm value. If contracts are optimally written and im- plemented, it’s expected that the derivative of firm value on changes in CEO incentive is zero. I test this hypothesis by estimating the treatment effect of changes in CEO incentive on firm value while controlling for a large set of lagged market, firm, board and CEO charac- teristics and using the inverse probability-of-treatment weighting method. I also use lagged firm policy variables as proxies for unobserved characteristics such as CEO risk aversion. Part of the results show that there is no significant effect of incentive adjustment on firm value, thus possibly confirming the optimality of CEO incentive contracts. However, there is also evidence that unobserved confoudning exists and the inherent endogeneity may bias the re…
author: Wang, Xiaolong
keywords: CEO compensation, Endogeneity, Firm performance, Incentive, Inverse probability-of-treatment weighting, Structural equations model
date published: 2020-01-01T08:00:00Z
date modified: 2026-07-24T01:39:50Z
provider: Claremont Graduate University
publisher: Networked Digital Library of Theses and Dissertations
type: WebPage
source organization: Claremont Graduate University