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E-MailThe following post comes to us from Jeffrey Coles, Professor of Finance at Arizona State University, and Zhichuan Frank Li of the Finance Department at Arizona State University.
In the paper, Managerial Attributes, Incentives, and Performance, which was recently made publicly available on SSRN, we examine the relative importance of firm- and manager-specific heterogeneities in determining the primary aspects of executive incentives and the implications of those incentives for firm policy, risk, and performance. We focus on the sensitivity of managerial wealth to stock price (delta) and the sensitivity of expected managerial wealth to stock volatility (vega) for top-five corporate executives.
First, following Graham, Li, and Qiu (2009), who apply the econometric approach of Abowd, Karmarz, and Margolis (1999) to executive pay level, we decompose the variation in executive incentives into time variant and invariant firm and manager components. We find that manager fixed effects and observable firm attributes combined supply 80-90% of explained variation in managerial delta and vega. Second, we find that specifications that do not accommodate firm and manager heterogeneity lead to erroneous parameter estimates on observed firm and manager characteristics. Third, there is a strong empirical association between the executive delta and vega fixed effects and attributes of managers and firms that are seen to proxy for manager human capital and risk version and firm marginal revenue product in application of manager skill. Finally, we find that larger CEO delta fixed effects are associated with higher Tobin’s Q and ROA and that CEOs with larger vega fixed effects implement riskier corporate policies, including higher R&D, lower capital expenditures, and lower fixed assets and there is a corresponding positive relation between executive vega and the volatility of firm stock returns.
Our results suggest that manager fixed effects capture managerial ability, human capital and risk aversion. Accordingly, future research reasonably would focus on developing better proxies for these characteristics and new models that identify other manager characteristics that determine firm structure, policy and performance.
The full paper is available for download at here.
