20 Dec 2017
Corporate actions are influenced by timing of CEO compensation, research by LBS professor finds
Papers co-authored by LBS Professor of Finance Alex Edmans have won the 2017 IRRC Institute Research Award.
The timing of stock-related chief executive officer (CEO) compensation is a predictor of corporate actions that boost short-term stock price but destroy long-term value, according to the two winning academic papers of the Investor Responsibility Research Center Institute (IRRCi) annual investor research competition. The winning academic research teams will share a $10,000 award.
“The two winning research papers use the vesting schedule for CEO compensation – when the CEO can sell stocks and options – to demonstrate that heavy vesting periods lead to actions that suggest that some CEOs are more concerned with short-term stock price movement than long-term value creation,” said Jon Lukomnik, Executive Director of IRRCi.
“These are the first papers to closely examine the structure of CEO equity vesting schedules and then correlate it to value-creating or value-destroying corporate activities.
“For example, the research finds that a high amount of equity vesting will increase the likelihood that a company will revise guidance upward; reduce research and development and capital expenditures; buy-back shares or increase the amount of its share buy-back; and even enter into merger and acquisition activity. The research paints a clear and bold portrait of short-termism with concern for long-term value creation faded into the background,” Lukomnik explained.
The first winning research paper, ‘Equity Vesting and Investment’, is co-authored by
Alex Edmans, Professor of Finance at London Business School; Vivian W. Fang, Assistant Professor of Accounting at Carlson School of Management at the University of Minnesota; and Katharina A. Lewellen, Associate Professor of Business Administration, Tuck School of Business at Dartmouth.
The paper studies the link between real investment decisions and CEO’s short-term stock price concerns. It finds that vesting equity induces CEOs to reduce investments in long-term projects and to take actions that increase short-term stock price. More broadly, it shows that that the structure of CEO compensation has a causal effect on real-world decisions. Download the research here.
The second winning paper, ‘The Long-Term Consequences of Short-Term Incentives’,
is also co-authored by Professor Edmans and Dr Fang, together with Allen H. Huang, Associate Professor in the Department of Accounting at Hong Kong University of Science and Technology. The paper studies two corporate actions that allow accurate measurement of the long-term consequences of short-term incentives – stock repurchases and mergers and acquisitions (M&A). The research shows that the impending vesting of equity may lead CEOs to take myopic actions that boost the short-term stock price at the expense of long-term value. An increase in vesting equity is associated with a greater frequency of stock repurchases and M&A announcements, and both corporate events were associated with higher short-term returns and lower long-term returns. Download the research here.
Professor Edmans said, “We are honored to win this award. With IRRCi's leading role in the practice of corporate governance, we hope our research can be used to guide the reform of executive pay.
“While pay does need to be improved, a correct diagnosis must precede treatment. Many views on executive pay – and thus calls for reform - are based on hand-picked anecdotes rather than large-scale evidence. While reformers often target the level of pay, our research suggests that the horizon of pay is a more important dimension. Giving CEOs equity with long vesting periods will encourage them to focus on long-term investment rather than short-term earnings.”
Dr Fang said, “For decades, both academics and practitioners have argued that short-term incentives hinder long-term growth. While intuitive, showing a causal effect of incentives on CEO actions is challenging because the same factors that drive CEO actions can also drive incentives.
“We use CEO vesting schedules - which were decided several years prior and thus are unlikely linked to current CEO actions - as a measure of short-term incentives. By linking vesting equity to firm outcomes that reflect value erosion, we show a negative causal effect of short-term incentives on firm value.”
The academic paper submissions were of such high quality that the judges selected one another research paper for Honorable Mention recognition, ‘Corporate Governance and The Rise of Integrating Corporate Social Responsibility Criteria in Executive Compensation: Effectiveness and Implications for Firm Outcomes’. This research is co-authored by Caroline Flammer, Assistant Professor of Strategy and Innovation at Boston University’s Questrom School of Business; Bryan Hong, Assistant Professor, General Management and Strategy at the University of Western Ontario’s Ivey Business School; and Dylan Minor, Assistant Professor of Managerial Economics and Decision Sciences at Northwestern University’s Kellogg School of Management.
This study also examines the structure of CEO compensation, and it finds that the integration of corporate social responsibility criteria in executive compensation – a relatively recent phenomenon – leads to an increase in long-term orientation; an increase in firm value; an increase in social and environmental performance; a reduction in emissions; and an increase in green innovations. Download the research here.
The respected judges for the 2017 IRRC Institute Prize were:
- Robert Dannhauser, Head of Capital Markets Policy, CFA Institute
- James Hawley, Professor emeritus and Director of the Elfenworks Center for Fiduciary Capitalism at St. Mary’s College of California
- Erika Karp, Founder, CEO and Chair of the Board of Cornerstone Capital
- Nell Minow, Governance Expert and Huffington Post Columnist.
The judges did not award a prize for a practitioner paper this year.
Biographies of the judges are available here. Information on past winners is available here. More information about the award is available here. Read the full body of IRRCi research here.
The IRRCi is a nonprofit research organization that funds academic and practitioner research that enables investors, policymakers and other stakeholders to make data-driven decisions. IRRCi research covers a wide range of topics of interest to investors, is objective, unbiased and disseminated widely. More information is available at www.irrcinstitute.org. Follow IRRCi on Twitter at @IRRCResearch.