Corporate Finance: Compensation and Agency
Friday, Jan. 5, 2024 8:00 AM - 10:00 AM (CST)
- Chair: Gustavo Manso, University of California-Berkeley
Competition and Executive Compensation: Evidence from Pharmaceutical Breakthrough Designations
AbstractWe examine the effect of competitive shocks on executive compensation and innovation in the pharmaceutical sector. The pharmaceutical sector is ideal for testing the joint theories of Arrow (1962) and Manso (2011) because innovation is paramount and periodic shocks to the competition space are common. Breakthrough therapy designations (BTDs), which expedite the approval of promising therapies, represent significant competitive shocks that are exogenous to rival firms' compensation structures. We find that when a pharmaceutical firm receives a BTD, rival firms respond by increasing risk-incentive pay via option grants in the subsequent year. This effect is robust to various econometric specifications and various ways of identifying rival firms. Furthermore, the observed effect is most pronounced for the most afflicted rivals (i.e., the rivals that exhibit the worst stock price reaction to the BTD) and for CEOs relative to other executives. We also examine if rival firms respond to the increase in executive stock options by shifting resources to riskier innovation. The evidence suggests that afflicted rivals escalate the developments of new drugs, initiate more drug projects using new technologies, and are more inclined to take on projects with lengthy development times. Overall, our results corroborate theoretical models wherein (i) firms facing competitive pressures optimally intensify innovation, and (ii) stock options encourage executives to undertake such innovation.
Process Intangibles and Agency Frictions
AbstractIntangible capital can be used to create new goods and services (product intangibles) or to improve the efficiency of the firm (process intangibles). We report and study a new empirical fact: Executive and skilled labor pay is increasing in firm process intensity (the fraction of intangibles corresponding to process intangibles). We rationalize this fact in a dynamic principal-agent model, with the optimal contract uncovering process intensity's direct and indirect effect on compensation. The direct effect is a level effect: Higher process intensity increases the returns to shirking. The indirect effect is a slope effect: Higher complementarity between process intangibles and physical capital investment increases the agent's hold-up power over the firm for any level of process intensity. We verify these effects in the data. Importantly, we show that these effects are present in executive compensation and in the wages of highly skilled innovative employees, which we can measure using proprietary granular vacancy posting data from a labor-market data firm. In our baseline specification, a one standard deviation increase in process intensity is associated with an 8% increase in executive pay and a 3% increase in skilled labor wages relative to industry peers.
ESG-linked Pay Around the World —Trends, Determinants, and Outcomes
AbstractWe conduct a large-scale global study of ESG-linked pay for major firms that make up 85% of the market capitalization across 59 countries. We find that the pay adoption is higher for firms in extractive and utility industries, in countries that value individualism and femininity, have stronger shareholder protections, and are of civil legal origin, and for large firms or firms with high return to assets. The adopters experience better future social and financial performances. Exploiting a regulatory shock that mandates corporate ESG disclosure, we show that the effect of ESG-linked pay on performances is likely causal and suggest employee satisfaction as a channel.
- G3 - Corporate Finance and Governance