Are Over-Paid Chief Executive Officers Better innovators?/?Los Directores Mejor Remunerados Son Mas Innovadores?

By Jouber, Habib | Journal of Economics, Finance and Administrative Science, December 2013 | Go to article overview

Are Over-Paid Chief Executive Officers Better innovators?/?Los Directores Mejor Remunerados Son Mas Innovadores?


Jouber, Habib, Journal of Economics, Finance and Administrative Science


1. Introduction

The underling goal of tying managers' compensation to the firm's performance is the division of management and shareholder functions caused by the separation of control and ownership. CEOs performance-based compensation is therefore considered as the most powerful tool to reward both managers and shareholders. There are several reasons for this consideration. First, within the publicly traded corporations executive pay is a large debated issue. Second, pay-to-performance policies have significant outcomes (i.e, shareholders and managers interests' alignment, talent CEOs' retention, risk-taking encouragement, cash scarcity, accounting and tax treatment). Third, equity-based incentive instruments aim the long term firm's value maximization rather than the short-term earnings amplification. Compensation paid is a widely investigated area of research by both academic scholars and practitioners. Nevertheless, some CEOs incentives' outcomes are still inconclusive such as their intended purpose of enhancing managerial risk preferences and therefore firm innovation. Except of few studies (sheikh, 2012; Wu & Tu, 2007), little is known about the effects of incentive rewards on the CEO's risk-taking behavior. In this study, we aim to fill this gap. Our baseline hypothesis is the well-established argument by agency theorists that CEOs who receive stock option compensation are more likely to make riskier decisions since they participate in the upside potential of these decisions but not in their downside. This "paradigm" in considering the strategic expenses' implications of CEOs equity compensation is to investigate whether CEO is really motivated to incur R&D expenses. Our sensibility analyses go beyond this paradigm by examining if CEOs of high R&D intensive firms are really rewarded for the induced firm's profitability. We consider firm innovation characteristics (R&D expenditures, patents and citations to patents) to proxy for managerial strategic decision making.

Our paper contributes to previous research in the area in two aspects. First, in response to Wu & Tu (2007)'s call for additional research to investigate separately the impacts of share-based and stock option-based compensation on R&D expenses, we have demonstrated that stock options encourage investment in value-increasing innovations better than stock rewards. (1) second, this study is the first to highlight, both from a "statutory" and an "activist" perspective (Bebchuck, Cohen & Ferrell, 2009), whether CEOs' intends to invest in value-enhancing innovations are contingent upon compensation committee independence and investor protection level.

The rest of the paper proceeds as follow. The next section provides the literature review and develops the hypotheses. section 3 describes the data, variables and empirical methodology. Results, implications and robustness tests are reported in section 4. The last section concludes.

2. Related literature and hypothesis development

2.1. Prior literature

Corporate governance theorists applaud the issue of CEOs performance-based compensation because they suggest that management incentive rewards yield immediate alignment of managers' interests with those of shareholders', which helps mitigate potential managerial opportunism and enhance firm value creation (Jensen & Meckling, 1976). Under this assumption, accounting and stock measures of performance are widely used in compensation contracts to interest the manager (agent) to maximize the owner's (principal) utility. (2) Shares and stock-options compensation plans can serve as a screening device to avoid adverse selection and moral hazard problems and hence, enhance firm value (Banker, Byzalov & Xian, 2011). Firm innovation is an important channel through which managers may increase firm value. Firm's innovation strategy can be characterized by different proxies such as patent counts (innovation magnitude), patent citations (innovation quality), technology class concentration, R&D expenditures, etc. …

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