Which Skills Matter in the Market for CEOs? Evidence from Pay for CEO Credentials

Abstract

M arket-based theories predict that differences in CEO skills lead to potentially large differences in pay, but it is challenging to quantify the CEO skill premium in pay. In a first step toward overcoming this empirical challenge, we code detailed biographical information for a large sample of CEOs for a panel of S&P 1500 firms between 1993 and 2005 to identify specific reputational, career, and educational credentials that are indicative of skills. Newly appointed CEOs earn up to a 5% or $280,000 total pay premium per credential decile, which is concentrated among CEOs with better reputational and career credentials, those with the very best credentials, and those who run large firms. Consistent with the unique economic mechanism of market-based theories, CEO credentials have a positive impact on firm performance. The performance differential for newly appointed CEOs is up to 0.5% per credential decile and is also concentrated among CEOs with better reputational and career credentials and those at large firms. Credentials are positively correlated with unobserved CEO heterogeneity in pay and performance, which further validates our hypothesis that boards use them as publicly observable signals of otherwise hard-to-gauge CEO skills. In all, our results offer direct evidence in support of market-based explanations of the overall rise in CEO pay.

CEO talent, CEO compensation, and product market competition

“…It then follows that the inferred factor profile that matches the observed CEO pay profile is flatter in the industry-level GL analysis, thereby leading to a lower impact estimate. Our perspective on CEO influence relative to GL's perspective is supported by the fact that our estimates are more in line with those reported by reduced-form approaches that employ observed CEO talent measures (e.g., Falato et al, 2015).…”

“…The estimates are closer to the reduced-form estimates in Falato et al (2015) that range between 1.7% and 2.5%. We exploit our model to disentangle the effects of CEO talent and product market characteristics on CEO impact.…”

“…A number of studies adopt reduced-form approaches to show significant effects of observed, but noisy, measures of CEO talent on firm value (e.g., Falato, Li, and Milbourn, 2015).…”

When Do Individual Bank Executives Matter for Bank Performance?

“…For example, Laderman (1994) finds that during the period from the 1989-1993 period, mutual funds managed by Ivy League graduates generally outperform their non-Ivy counterparts. More recently, Falato et al (2014) demonstrate that CEOs who study at more selective institutions are paid at a premium and this effect is associated with talent.…”

Matching and Winning? The Impact of Upper and Middle Managers on Team Performance

“…Among others, Goodall and Poterba (2014) and Goodall et al (2011), document the positive impact of high quality worker experience on managerial leadership. See Kaplan et al (2012) for a study on the impact of personality traits, such as empathy and directness, Falato et al (2015) for an assessment of the importance of CEO reputation and Malmendier et al (2011) for evidence on the impact of birth cohorts on managerial policy making.…”