CEO compensation and future shareholder returns: Evidence from the London Stock Exchange

• Published in: Journal of empirical finance 2014-06, Vol.27, p.97-115
• Main Authors: Balafas, Nikolaos, Florackis, Chris
• Format: Article
• Language: English
• Subjects: CEO compensation; Chief executive officers; Corporate governance; Economic incentives; Economic performance; Executive pay; Incentive/equity-based pay; Operating performance; Regression analysis; Stock exchange; Stock returns; United Kingdom
• ISSN: 0927-5398; 1879-1727
• DOI: 10.1016/j.jempfin.2013.10.011

This study examines the ex-post consequences of CEO compensation for shareholder value. The main objective is to explore whether companies that pay their CEO excessive fees (in comparison to those of peer firms in the same industry and size group) generate superior future returns and better operating performance. Our analysis, which separately considers the cash-based and incentive/equity-based components of CEO compensation, is based on a large sample of UK-listed companies over the period 1998–2010. We find that CEO incentive pay is negatively associated with short-term subsequent returns. Interestingly, firms that pay their CEOs at the bottom of the incentive-pay distribution earn positive abnormal returns and, also, significantly outperform those at the top of the incentive-pay distribution. Further analysis reveals that such outperformance can be largely explained by the excessive exposure of low-incentive-pay firms to idiosyncratic risk. Finally, evidence from panel regressions suggests that, in addition to its negative relationship with returns, incentive pay is also inversely associated with future operating performance. •CEO incentive pay is negatively associated with short-term subsequent returns.•Idiosyncratic risk largely explains the outperformance of low-incentive-pay firms.•CEO incentive pay is also inversely associated with future operating performance.