Do Higher Paid CEOs Weather the Storm Better? Evidence from the Great Recession

1. Do Higher Paid CEOs Weather the Storm Better? Evidence from the Great Recession Wei-Ling Song E.J. Ourso College of Business Louisiana State University Hsiangping Tsai College of Management Yuan Ze University

2. Background & Motivation • The collapse of Lehman Brothers • The say-on-pay rules in the Dodd-Frank legislation • Shareholder’s reaction • Kaplan (2011): Shareholders support • More than 98% of S&P 500 firms • The empirical evidence • Agency problem → CEOs are overpaid • Bebchuk et al. (2011): CPS (CEO pay slice) negatively correlated with firm value measured by Tobin’s q • Liu and Jirapon (2010):Firms with more powerful CEOs (higher CPS) exhibit lower credit ratings & higher at-issue bond yields.

3. Main Idea • Excessive CEO pay may proxy for • Agency problem • Unobserved CEO ability • To test the CEO ability hypothesis • Use CDS spreads and Tobin’s q during the Great Recession • If “excessive” CEO pay is a proxy for unobserved CEO ability, then firms with such CEOs should experience lower increases in CDS spreads and lower declines in Tobin’s q • CPS (CEO pay slice)

4. The CEO ability hypothesis • Boot and Thakor (2011) • Manager-investor disagreement in project choices • CEO power & the cost of external financing: positive correlated • An alternative explanation to Bebchuk et al. (2011) • Bebchuk et al. (2011): CPS negatively correlated with firm value measured by Tobin’s q • Firms with higher manager-investor disagreement • difficult to manage →need high ability CEO →high pay. • Larger agency problem than firms with low manager-investor disagreement • i.e. agency problem and high CEO ability may co-exist

5. The value implicationduring crisis • Agency problem hypothesis • High CPS firms → higher CDS spread increases • High CPS firms → higher declines in Tobin’s q • CEO ability hypothesis • High CPS firms → lower CDS spread increases • High CPS firms → lower declines in Tobin’s q

6. Sample selection • CDS spread • Senior 5-year term CDS quotes • ExecuComp& IRRC (CG data) • Final sample: 407 firms • Following Bebchuk et al.(2011) • CEO tenure>=1 year • Firms reporting top 5 executive compensation • 332 industrial firms and 75 financial firms

7. Variables • CPS (CEO pay slice) • The fraction of the total top five executives’ compensation that goes to CEO. • Total Compensation (TDC1) • High vs. low CPS firms • High: Firms with above median ind-adj CPS during the fiscal year prior to the Lehman Crisis • The main measures use ind-adj figures • Ind-adj CPS • Ind-adj Tobin’s q

8. Variables (continued) • CEO risk-taking incentive variables • CEO inside debt variables (Wei and Yermack 2011) • Delta and vega (Core and Guay 2002) • Ind-adj cash flow volatility (Parrino and Weisbach 1999) • Governance variables • Bebchuk et al. (2011)

9. Sample distribution (1)

10. Sample distribution (2)

11. Median CDS spread by CPS

12. Time-line for event windows

13. CDS spreads by CPS type and by event window

14. Summary statistics by CPS types-fiscal year prior to the Lehman Crisis

15. Summary statistics by CPS types-fiscal year prior to the Lehman Crisis

16. Summary statistics by CPS types-fiscal year prior to the Lehman Crisis

17. Change in CDS spread surrounding the Crises

18. Change in CDS spread surrounding the Crises (control for CEO risk-taking)

19. Change in Tobin’s q surrounding the Lehman Crisis

20. Change in Tobin’s q surrounding the Lehman Crises (control for CEO risk-taking)

21. Conclusion • High CPS firms performed better than low CPS firms during the Great Recession • CDS spreads/ Tobin’s q • Consistent with the CEO ability hypothesis • Higher paid CEOs can navigate through tough times better than lower paid CEOs • CPS captures elements of both CEO ability and the agency problem • The common managerial rent extraction proxies used in the literature are also likely to capture managerial ability.