Certain characteristics of managerial employment arrangements and of the managerial labor market make shareholder wealth dependent on an executive's continued employment. These wealth effects are investigated by examining the common stock price reaction to unexpected deaths of senior corporate executives. Abnormal stock price changes are documented for a sample of fifty-three events. These abnormal stock price changes are associated with the executive's status as a corporate founder and with measures of the executive's' talents' and decision-making responsibility, and of the transaction costs associated with renegotiating or terminating the employment agreement.
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The relative performance evaluation (RPE) hypothesis states that firms benefit from comparing their own performance to that of a peer group when evaluating the CEO's performance. Although in theory firms should be employing relative performance to evaluate the CEO, indirect empirical tests in the 1980s and 1990s generally fail to support the RPE hypothesis. This paper examines RPE-related disclosures found in the compensation committee reports provided in proxy statements to determine whether firms actually employ RPE, and to offer insight into why indirect tests generally fail to support the RPE hypothesis. We find that firms do use RPE in determining executive compensation, thus supporting the RPE hypothesis, although RPE usage is not widespread. We also find that several key assumptions underlying prior indirect tests are misspecified for many firms, helping to explain the difficulty in detecting RPE in random samples of firms and suggesting improvements to methodologies employing indirect tests for RPE. Our results also beg the question of why some firms use RPE while other firms do not. We find that RPE usage is positively related to greater monitoring and stakeholder concern about pay and performance, but that performance and CEO power and insulation from pressure do not explain cross-sectional variation in RPE usage. We also examine disclosures related to peer groups and adverse performance-related events since they indirectly relate to RPE and find that many firms filter out negative-performance-related events, but not positive ones. This is equivalent to using one-sided RPE, where a firm excuses the CEO from factors that affect industry performance adversely, but credits the CEO for factors that aid industry performance.
We investigate whether footnote disclosures under Statement of Financial Accounting Standards (SFAS) No. 123 are managed in 1996, the first year that the disclosure was required. The 1996 phase-in of SFAS No. 123 provided firms with a unique opportunity to manipulate the pro forma disclosure in the initial years. SFAS No. 123 allows firms discretion in estimating the value of their stock option grants and in allocating that value across accounting periods. Although we find little evidence that firms manage the estimated value of their option grants, we find that firm-specific incentives affect how that value is allocated. Specifically, firms that provide high levels of either CEO compensation or stock option compensation relative to performance allocate a smaller proportion of the options' value to the 1996 pro forma expense, apparently to reduce criticism of that compensation. Small firms and firms that recently went public also allocate a smaller proportion of option value to the 1996 pro forma expense, apparently to increase perceptions of their profitability. We conjecture that firms were less likely to manage the value of the options granted than the allocation of that value in 1996 because the parameter estimates underlying the reported option value must be disclosed in the footnote, whereas the inputs to the allocation computation are not disclosed. These results, which suggest that firms manipulated pro forma stock option expense when their estimate choices cannot be observed, have implications for both standard setters and financial statement users. In particular, the FASB's current deliberations on the transition from footnote disclosure to income statement recognition for stock options should consider additional disclosures to minimize unobservable choices. More generally, the FASB may reduce potential manipulation by requiring expanded disclosures about the choices used in computing both pro forma and reported numbers.
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