Incentive Effects of Extreme CEO Pay Cuts

摘要

We examine the causes and consequences of sharp CEO pay cuts, a phenomenon that has been mostly overlooked in the attention paid to overall rising executive pay. We find that large CEO pay cut is not uncommon and triggered by poor performance. Good corporate governance structures strengthen the link between poor performance and CEO pay cut. After the pay cut, the CEO can restore his pay level by reversing the poor performance. Pay cuts are only a short-term substitute for dismissal—a pay-cut CEO with continued poor performance is just as likely to be dismissed as a CEO with similar performance whose pay was not cut. On average, CEOs respond to their pay cut by curtailing capital expenditures, reducing R&D expenses, and allocating funds to reduce leverage. For most firms, performance improves and the CEO’s pay is restored. Compared to option repricing, pay cuts appear to be more effective in improving firm performance. Together, our results show that the dynamic changes to CEO compensation packages provide ex ante incentives for them to exert effort to avoid poor performance and ex post incentives to improve poor performance if it is experienced.