Premium Pay for Executive Talent

In the paper, Premium Pay for Executive Talent: An Empirical Analysis, which was recently made publicly available on SSRN, we study the extent to which executive talent affects executive compensation design. Although the effect of executive-specific characteristics on firm choices and outcomes is the subject of a large literature in organizational theory, economics, and finance, not much direct evidence is available on the association between executive-specific characteristic of talent and compensation contracts.

We derive three proxies to capture the executive’s talent using principal components analysis. The first component captures the “perceived” dimension of talent, based on whether the executive was a CEO at the previous firm, tenure in a prior top position, excess pay at the previous firm, and the press coverage while at the previous firm. Our other two proxies capture measurable outcomes of actions at the prior employer. One measures talent using accounting and stock price performance at the prior firm. The other captures talent by relying on reporting quality, namely whether the prior firm has been subject to an AAER or has restated its earnings.

Using a sample of 1,844 executives who represent 2,021 job switches at 1,700 unique ExecuComp firms between 1992-2007, the results from our main analyses indicate that, incremental to standard determinants of executive pay, executives with greater talent receive higher pay at their new employers. Our approach allows us to draw inferences about the potential causal link between talent and pay, by focusing on job switches and thereby separating the executive from the firm, rather than observing talent and pay concurrently at the same company. Our conclusions are robust to the consideration of other potential effects including the change in the executive’s position during the switch, the properties of the switch, and compensation for forfeited pay from the prior employer that may occur in the first year at the new employer. These findings suggest that there is a reward for talent that is incremental to the new position of the executive and incremental to pay based on the economic characteristics of the new employer. That these executives are paid a premium potentially reflects competition in the labor market for skilled executives.

We also examine whether paying for talent is associated with superior performance at the hiring firm but find mixed results that pay premiums for talent translate into greater accounting and stock price performance of the new employer. Our talent proxy based on performance at the prior firm is positively associated with accounting performance at the new company. But, our “perceived” talent measure is negatively associated with both accounting and stock price performance at the new firm, suggesting that paying for “perceived” talent may not pay off for the hiring firm.

The full paper is available for download here.