"Insurer Reserve Error and Executive Compensation" 

Journal of Risk and Insurance, Vol. 77, Issue 2, pp. 329-346, June 2010

DAVID L. ECKLES, affiliation not provided to SSRN
MARTIN HALEK, University of Georgia - Department of Insurance, Legal Studies, Real Estate
Email: mhalek@uga.edu

This article investigates incentives of insurance firm managers to manipulate loss reserves in order to maximize their compensation. We find that managers who receive bonuses that are likely capped or no bonuses tend to over-reserve for current-year incurred losses. However, managers who receive bonuses that are likely not capped tend to under-reserve for current-year incurred losses. We also find that managers who exercise stock options tend to under-reserve in the current period.

"Compensation and Board Structure: Evidence from the Insurance Industry" 

Journal of Risk and Insurance, Vol. 77, Issue 2, pp. 297-327, June 2010

DAVID MAYERS, University of California, Riverside - A. Gary Anderson Graduate School of Management
Email: david.mayers@ucr.edu
CLIFFORD W. SMITH, affiliation not provided to SSRN

Monitoring by outside board members and incentive compensation provisions in executive pay packages are alternative mechanisms for controlling incentive problems between owners and managers. The control hypothesis suggests that if incentive conflicts vary materially, those firms with more outside directors also should implement a higher degree of pay-for-performance sensitivity. Our evidence is consistent with this control hypothesis. We document a relation between board structure and the extent to which executive compensation is tied to performance in mutuals: compensation changes are significantly more sensitive to changes in return on assets when the fraction of outsiders on the board is high.

"Malfeasance, Misappropriation, Manipulation — or Not?" 

Regulation, Vol. 33, No. 1, pp. 10-15, Spring 2010

RICHARD A. BOOTH, Villanova University School of Law
Email: booth@law.villanova.edu

Stock options are the primary form of compensation for CEOs because they align the interests of CEOs with those of diversified stockholders. Nevertheless, critics argue that the use of options leads to excessive pay because there is no effective bargaining between the CEO and the board of directors about the number of options to award. This article argues that this objection does not withstand scrutiny, because options are subject to powerful market forces that control their use.

"The Best Approach to Executive Compensation" 

CRISIL Young Thought Leader Competition, 2009

R. J. MASILAMANI, BIMTECH
Email: rj.masilamani@bimtech.ac.in
SHIVA KUMAR AMARESAN, Birla Institute of Management Technology (BIMTECH)
Email: shivkumara27@yahoo.com

Executive compensation is one of the most debated topics. It is seen by most to be undeservedly high and has attracted serious criticism from both investors and government. The ratio of the salary of CEO’s to that of the lowest level worker has seen a drastic increase in the last decade. Such increasing income inequality was tolerated as long as the rising tide was lifting all ships. While the US government is moving towards a tightening of the screws by introducing new regulations, the Indian government is now relaxing the 5% cap on managerial remuneration imposed by the Companies Law.

It is really unfortunate that the current set of practices regarding executive compensation is very short term focused. The rewards paid are based on claims not actual results. The world of business has witnessed an unusually large number of corporate scandals in its relatively short history. There seems to be a lack of accountability. Executives are not really held responsible for their decisions. There seems to be only one direction in which executive compensation is headed - towards disaster.

A good executive compensation system should take into consideration the total basket of employee’s needs and not just the short term financial ones. It should feature non monetary needs of the employees and focus on the basic objective of retaining and motivating good people. Most importantly it should be long term performance based. Each decision of a manager has a time duration in which its outcome and impact can be reasonably assessed. The incentive part of the compensation should be held in a performance incentive escrow account. When the decision has produced the expected and desired results, the funds from this account can be released. If the decision turns awry, the executive has to be penalized by deductions from the escrow account. The funds in the escrow account can be invested as per the discretion of the executive. This would ensure that the executive works for the long term interests of the company rather than maximizing his current annual emoluments.

The major challenge would lie in convincing the business world of the need for introspection on this critical issue and to induce a willingness to develop a new, viable and appropriate approach to executive compensation incorporating the relevant issues. To this end the paper focuses on the core aspects of compensation and offers analysis and suggestions that can form the basis of a just new world of managerial remuneration.

"Public Opinion and Executive Compensation" 

CAMELIA M. KUHNEN, Northwestern University - Kellogg School of Management
Email: c-kuhnen@kellogg.northwestern.edu
ALEXANDRA NIESSEN, University of Mannheim
Email: niessen@bwl.uni-mannheim.de

We inquire whether public opinion influences executive compensation. During 1992-2008 the negativity of press coverage of CEO pay varied significantly, with stock options being the most discussed pay component. We find that after more negative press coverage of CEO pay firms reduce option grants and increase other compensation including stock awards, overall reducing pay-to-performance sensitivity. The reduction in option pay after increased press negativity is more pronounced when firms and CEOs have stronger reputation concerns. Our within-firm, within-year identification shows the results cannot be explained by annual changes in accounting rules regarding executive compensation, stock market conditions, or pay mean-reversion.

"Deferred Compensation, Risk, and Company Value: Investor Reactions to CEO Incentives" 

FRB of New York Staff Report No. 445

CHENYANG (JASON) WEI, Federal Reserve Bank of New York
Email: chenyang.wei@ny.frb.org
DAVID YERMACK, New York University - Stern School of Business
Email: dyermack@stern.nyu.edu

Many commentators have suggested that companies pay top executives with deferred compensation, a type of incentive known as inside debt. Recent SEC disclosure reforms greatly increased the transparency of deferred compensation. We investigate stockholder and bondholder reactions to companies’ initial reports of their CEOs’ inside debt positions in early 2007, when new disclosure rules took effect. We find that bond prices rise, equity prices fall, and the volatility of both securities drops upon disclosures by firms whose CEOs have sizable defined benefit pensions or deferred compensation. Similar changes in value occur for credit default swap spreads and exchange-traded options. The results indicate a reduction in firm risk, a transfer of value from equity toward debt, and an overall destruction of enterprise value when a CEO’s deferred compensation holdings are large.

"New Performance-Vested Stock Option Schemes" 

AN CHEN, Department of Economics, University of Bonn
Email: an.chen@uni-bonn.de
MARKUS PELGER, University of California, Berkeley - Department of Economics
Email: markus.pelger@berkeley.edu
KLAUS SANDMANN, University of Bonn - The Bonn Graduate School of Economics
Email: k.sandmann@uni-bonn.de

A big debate in current corporate ?nance is whether executives’ stock options have actually encouraged managers to take on too large risks which eventually jeopardize a ?rm’s performance. In the present paper, we advocate two e?ective non-traditional performance-based stock option schemes which discourage mangers from excessive risk taking: Parisian and Asian executives’ stock option plans. Under a Parisian option scheme, managers can only be rewarded if the stock price has outperformed a certain stock price for a ?xed length of time. Under an Asian scheme, the executives’ compensation is coupled with the average performance of the stock price. Both schemes make the exaggerated risk taking through the executives less likely. In the Parisian scheme, it can be achieved by setting the length of excursion su?ciently long and in the Asian scheme, by requiring the average rate of return of the stock to exceed a relatively high ?xed rate of return. We focus on the valuation of these new performance-vested stock options and conduct some numerical analyses based on the valuation formulae we obtain.

"Cost Behavior and Executive Compensation" 

MARCUS L. CAYLOR, University of South Carolina - Department of Accounting
Email: marcus.caylor@moore.sc.edu
THOMAS J. LOPEZ, University of Alabama - Culverhouse School of Accountancy
Email: tjlopez@cba.ua.edu

Prior literature provides compelling evidence of an asymmetric relation between executive bonus compensation and earnings performance. In particular, this literature reports that compensation committees assign greater weight to good (positive) earnings performance than poor (negative) earnings performance. Taken together, the prior literature provides strong support for critics who claim that compensation committees blindly protect executives from earnings underperformance. We further examine this issue by investigating whether a firm’s cost behavior (i.e., the relation between expenses and sales) provides an explanation for the apparent inefficiency in executive compensation contracts. Our evidence suggests that executives are rewarded more for increases in ROA that arise from normal cost behavior than other increases in ROA consistent with these increases being perceived as more persistent. In contrast, we do not find such a relationship for decreases in ROA which suggests that executives are largely shielded from decreases in ROA that follow normal cost behavior. We examine two factors suggested by the prior literature, expected future sales and the extent of capacity utilization, which may provide an explanation for why executives are shielded from normal cost behavior decreases in ROA. When these additional factors are included in our empirical models, our evidence suggests that the asymmetric relation between changes in CEO bonus compensation and increases and decreases in earnings performance documented in prior literature goes away. That is, our results suggest that compensation committees do not blindly protect executives for earnings underperformance. On the contrary, our evidence suggests that these committees take into account other non-earnings information when deciding how much weight to give to a decrease in earnings and that executive compensation may not be as inefficient as suggested by prior research.