DAVID F. LARCKER, Stanford University - Graduate School of Business
Email: Larcker_David@gsb.stanford.edu
BRIAN TAYAN, Stanford Graduate School of Business
Email: btayan@stanford.edu

By 2007, executive compensation at U.S. companies had become an extremely contentious topic. Reports in the press of multi-million dollar pay packages - in the form of stock option exercises, severance packages, and retirement payouts - led to an outcry among many investors that compensation levels had gotten out of hand. Negative sentiments were highest against CEOs who received large severance payments despite the fact that the price of the company's stock had decreased substantially during their tenure. Corporate governance watchdogs dubbed such situations "pay for failure."

Critics of executive compensation levels advocated a series of actions to rein in pay. These included increased disclosure about previously obscure contract provisions for severance and retirement packages, urging shareholders to withhold votes from directors who approved excessive pay amounts, and the requirement that executive compensation packages be put before shareholders each year for an advisory vote. This last proposal, commonly referred to as “say on pay,” would give shareholders a direct voice (using the proxy voting procedures) for the first time on CEO compensation. Advocates of say on pay believed that the practice would put pressure on directors to justify proposed compensation amounts rather than rubber stamp pay packages proposed by boards and consultants. They also believed it would improve dialogue between shareholders and directors. Critics charged that the say-on-pay movement was politically motivated by activist investors and public pension funds who were trying to gain influence over matters that should be decided by elected board members. Average shareholders were left to consider what effects, if any, say on pay would have on compensation trends and whether it offered an innovative corporate control or an unnecessary distraction for CEOs and board members.

PETER KATUSCAK, Charles University in Prague - CERGE-EI (Center for Economic Research and Graduate Education - Economics Institute)
Email: Peter.Katuscak@cerge-ei.cz

This paper analyzes the effect of personal income taxation on the pay-to-stock-price sensitivity of executive compensation contracts generated by stock option and restricted stock grants. Using Execucomp data for 1992-1996 and variation in the ordinary income marginal tax rate of top earners in the same time period, I find that an increase in the tax rate decreases the pre-tax pay-to-performance sensitivity generated by option grants, whereas stock grant sensitivity is found to be unresponsive to the same change. Even though these results can be explained by joint tax optimization of executives and their employers, they suggest that after-tax incentive provision for executives is quite sensitive to variation in the ordinary income tax rate.

GIAN LUCA CLEMENTI, NYU Stern School of Business
Email: gclement@stern.nyu.edu
THOMAS F. COOLEY, Leonard N. Stern School of Business - Department of Economics, National Bureau of Economic Research (NBER)
Email: tcooley@stern.nyu.edu

In this paper we describe the important features of executive compensation in the US from 1993 to 2006. Some confirm what has been found for earlier periods and some are novel. Important facts about compensation are that: the compensation distribution is highly skewed; each year, a sizeable fraction of chief executives lose money; the use of equity grants has increased; the income accruing to CEOs from the sale of stock has increased; regardless of the measure we adopt, compensation responds strongly to innovations in shareholder wealth; measured as dollar changes in compensation, incentives have strengthened over time, measured as percentage changes in wealth, they have not changed in any appreciable way.

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ING-HAW CHENG, University of Michigan, Ross School of Business
Email: ingcheng@umich.edu
HARRISON G. HONG, Princeton University - Department of Economics
Email: hhong@princeton.edu
JOSE A. SCHEINKMAN, Princeton University - Department of Economics, National Bureau of Economic Research (NBER)
Email: joses@princeton.edu

We investigate the link between compensation and risk-taking among finance firms during the period of 1992-2008. First, there are substantial cross-firm differences in total executive compensation residualized for firm size. Second, residual pay is correlated with price-based risk-taking measures including firm beta, return volatility, tail cumulative return performance, and the sensitivity of firm stock price to the ABX subprime index. Third, residual compensation is also weakly correlated with balance-sheet based risk-taking measures such as holdings of non-GSE mortgage-backed securities and book leverage. Fourth, these risk-taking measures are correlated with residual pay even though executives are highly incentivized as measured by insider ownership. Finally, compensation and risk-taking are not related to governance variables but covary with ownership by institutional investors who tend to have short-termist preferences and the power to influence firm management policies. Our findings suggest that our residual pay measure is picking up other important high-powered incentives not captured by insider ownership. They also point to substantial heterogeneity in both firm culture and investor preferences for short-termism and risk-taking.

AARON ZELINSKY, Yale Law School
Email: Aaron.Zelinsky@yale.edu

Section 162(a)(1) of the Internal Revenue Code, as construed by the IRS, effectively allows publicly traded businesses to deduct an unlimited amount of executive compensation for corporate tax purposes. In contrast, the IRS has consistently used § 162(a)(1) to limit corporate deductions for executive compensation paid by closely held corporations. This Comment proposes that, in light of recent scholarship, the IRS has misapplied § 162(a)(1), since publicly traded corporations may lack the appropriate oversight and incentive infrastructure to set executive compensation reasonably. Therefore, this Comment proposes that the IRS should use § 162(a)(1) to render such compensation nondeductible, just as the Service examines the deductibility of compensation paid by privately held corporations.

MARTIJN CREMERS, Yale School of Management
Email: martijn.cremers@yale.edu
ROBERTA ROMANO, Yale Law School, National Bureau of Economic Research (NBER), European Corporate Governance Institute (ECGI)
Email: roberta.romano@yale.edu

This paper examines the impact on shareholder voting of the mutual fund voting disclosure regulation adopted by the SEC in 2003, using a paired sample of management proposals on executive equity incentive compensation plans submitted before and after the rule change. While voting support for management has decreased over time, we find no evidence that mutual funds' support for management declined after the rule change, as expected by advocates of disclosure. In fact, we find evidence of increased support for management by mutual funds after the change. There is some evidence that firms sponsoring such proposals both before and after the rule change differ from those sponsoring a proposal only before the change. For example, firms are more likely to sponsor a proposal both before and after the rule change if they have higher mutual fund ownership. Such endogeneity could partly explain our findings of increased support after the rule.