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

Background & Motivation 2 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.

Main Idea 3 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)

The CEO ability hypothesis 4 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

The value implication during crisis 5 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

Sample selection 6 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

Variables 7 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

Variables (continued) 8 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)

Sample distribution (1) 9

Sample distribution (2) 10

Median CDS spread by CPS 11

Time-line for event windows 12

CDS spreads by CPS type and by event window 13

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

Change in CDS spread surrounding the Crises 17

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

Change in Tobin’s q surrounding the Lehman Crisis 19

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

Conclusion 21 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.