manager's job

    This study helps clarify the conflicting results in the CEO pay-performance

 

literature. The research argues that mixed results are in part because researchers

 

tend to conflate several constructs. The primary components of testing the

 

efficacy of top executive compensation package are structure, size, and risk

 

aversion of the CEO. Companies often argue that they structure CEO pay to

 

maximize shareholder value. This research addresses the question of whether

 

CEO pay tends to be structured appropriately. It provides evidence on one

 

component of evaluating the appropriateness of CEO pay.

​

   One strand of the literature on CEO compensation focuses on the structure of

 

the compensation contract, such as the proportions of incentive-based versus.

 

fixed compensation. Another strand of research is focused on the sensitivity of

 

pay to performance; Baker and Hall have elements of both streams. Gormley

 

finds that boards tend to reduce the proportion of the CEO's pay that is based on

 

options and stocks when risk in the environment increases. They also find that

 

CEOs do not sufficiently reduce their risk-taking activities even after boards have

 

signaled that they expect reduced risk taking.

​

   In contrast to Gormley, this study discusses explicitly control for risk in the firm's

 

operating environment and do not restrict risk to a single shock. This is important

 

because boards may respond to one-off shocks with changes in CEOs'

 

compensation by reducing the risk implicit in them. The typical CEO is assumed to

 

be risk averse, so should require that a greater portion of her compensation be

 

fixed as risk increases. My results show that the variable portion of compensation

 

tends to increase as risk in the operating environment increases.

​

   Compensation packages would be structured to incorporate differences in risk

 

aversion between CEO’s and their managers. Boards of directors often must infer

 

a portion of the information needed to set the CEO's compensation. Given the

 

challenges boards face in the CEO pay setting process, it is important to assess

 

how the outputs of their efforts are the relationship between CEO pay and risk

 

generally decreases monotonically as risk in the operating environment

 

increases. However, this study finds that it tends to increase. This is due to at

 

least four factors, including revaluation of stock and option awards. The results of

 

this study suggest that firms make significant attempts to align the interest of

 

shareholders with those of CEO’s.

​

   CEOs with lower levels of risk aversion may be more attracted to riskier firms or

 

firms facing financial distress. Some CEOs may find that they can increase their

 

stock-based compensation by taking riskier actions. The structure of a significant

 

portion of CEOs' pay is not directly tied to performance. This phenomenon may

 

be a consequence of attempting to shield the CEO from outcomes she may have

 

little control over. In such a situation, relying more on accountancy measures

 

implicitly invokes Holmstrom's informativeness.

​

   The variable portion of CEOs' total compensation tends to increase as risk in the

 

operating environment increases. This study can help increase policy-makers'

 

understanding of the economic rationale behind the pay setting process. It would

 

be fruitful for researchers to examine CEO pay in the context of both structure

 

and size, conditional on performance and operational risk. The results suggest

 

that at least in the extreme volatility settings, firms attempt to structure CEO pay

 

in a way that is consistent with agency theory. The theory suggests that

 

companies attempt to balance providing incentives with sharing risk between the

 

firm and the CEO while paying attention to the level of risk the CEO might be able

 

to bear.

​

   It is possible that CEOs self-select into companies depending on their level of

 

risk aversion, rather than being selected by firms. The increasing proportion of

 

variable pay as risk in the operating environment may support the notion that

 

risk adverse CEOs value stocks and options less than their intrinsic values. It is

 

assumed that the representative shareholder is close to risk neutral. While most

 

of the results are consistent with agency theory, the interpretation should be

 

balanced with the reality that levels of risk aversion of CEOs can vary dramatically

 

in practice.

​

Work Cited

Asare, Kwadwo. “Variability in Cashflows and Returns and Ceo Pay.” Journal of Theoretical Accounting Research, vol. 17, no. 1, Fall 2021, pp. 65–103. EBSCOhost, search.ebscohost.com/login.aspx?direct=true&AuthType=ip,shib&db=bth&AN=151519170&site=bsi-live.