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E-MailAddis Birhanu is Assistant Professor in the Department of Strategy and Organization at Ecole de Management de Lyon (EM Lyon). This post is based on a recent paper by Ms. Birhanu; Philipp Geiler, Associate Professor of Economics at EM Lyon; Luc Renneboog, Professor of Finance at Tilburg University; and Yang Zhao, Senior Lecturer in Financial Data Analysis at the University of Liverpool.
The experience that executive and non-executive directors accumulate by working in specific corporate positions within and across industries is one of the most important dimensions of their human capital. Previous studies document that variance in directors’ pay is primarily driven by differences in human capital accumulated over career paths. However, we know little about if and why (executive and non-executive) directors are paid differently across and within firms for what appears to be the same stock of human capital.
We address this question by focusing on a task-specific experience, namely that of M&A experience, and investigate whether this experience is priced in the remuneration contracts of directors. Acquisition experience of directors deserves attention for the following reasons. First, takeovers are complex operations that require expertise to identify an appropriate target, undertake the required due diligence, assess the potential synergistic value contribution of the target, raise the acquisition financing, and decide on the level of integration with subsequent implementation. Second, acquisitions are strategic decisions that typically require large investments and profoundly affect a company’s growth, value creation, and long-term prospects. Third, unsuccessful acquisitions are far from rare; the combined cumulative abnormal returns (CARs) of bidder and target are negative in almost half of the acquisitions and long-term performance of merged firms does in most cases not exceed the performance of matched peer companies that did not merge. Acquisition failures are often attributed to lack of experience with the takeover process at the managerial, non-executive, and firm level. Fourth, acquisitions are one of the very few strategic decisions that require intensive communication and deliberation by both executive and non-executive directors.
With this in mind, we examine whether executive and non-executive directors receive a pay premium in their remuneration contract for acquisition experience. We study differences in compensation related to this experience not only across but also within firms (as even for non-executive directors there are significant remuneration differences within firms). We use a rich dataset that covers all constituents of the FTSE All-Share Index, 2,243 unique firms, over a period of 17 years (1999-2016).
Our study unveils four important facts: (1) acquisition experience increases a director’s total remuneration, and this relation is stronger for (2) non-executive directors (relative to their executive counterparts). The latter finding is not surprising; given that many takeovers turn out to be ex-post failures, takeover experience is particularly important for non-executive directors in their advisory and supervisory capacity. (3) Only experience with successful takeovers is priced in directors’ remuneration contracts. (4) In firms where acquisition experience is scarce, an individual’s experience is valued more compared to firms where this experience is already abundantly present.
In the analyses yielding the above findings, we control for a broad set of experience and managerial skills director gained through working in different positions (e.g. as CFO or CEO), firms, and industries, and include director-firm fixed effects to rule out time-invariant director and firm level effects that may affect remuneration. Robustness tests based on an instrumental variable approach and alternative measures of director acquisition experiences confirm our results.
These findings contributes to the literature of remuneration and human capital in the following ways. First, while the human capital literature focuses primarily on general managerial experience, measured by the positions held within or across firms and industries without considering the actual tasks performed, we examine task-specific human capital (here acquisition experience). We analyse whether such experience is ‘appreciated’ at the remuneration contractual level. Second, novel is also that firms weigh the expected effectiveness of this experience by the role a director plays in a corporate context, as the relative importance of acquisition experience is large for non-executive directors. This suggest that some non-executive directors are hired specifically for ability to judge the potential of potential acquisition targets. Third, firms are able to clearly discriminate between acquisition experience based on past successful takeovers and past failures, and only pay a premium for the former. Hence, firms discount the idea that having been involved in a failure also constitutes an interesting experience and learning opportunity. Fourth, firms seem to carefully deliberate whether they need task-specific experience, or at least, whether they want to pay for this. That is, firms without much collective acquisition experience recognize the importance of acquisition experience of directors by offering a higher remuneration.
By providing evidence on how much acquisition experience matters for remuneration of directors and examining some boundary conditions to it, this study opens up a new direction for future research. Similar studies like ours may guide directors to understand and invest in the portfolio of expertise and skills that are most rewarded by the labour market.
The complete paper is available for download here.
