1. Asymmetric benchmarking in compensation: ~Executives are rewarded for good luck but not penalized for bad Garvey & Milbourn (2006) Jeremy Carlson & Megan de Villiers (2010)
2. Structure Define “Luck” Methodology Findings Implications Milbourn & Garvey recommendations Alternate interpretations Further exploration Q & A
3. “Luck” Defined “Exogenous forces” (199) Measured by market-based indices – “imperfect measures” (207) E.g. Value- or Equal- weighted market return (207) Size decile-based returns (207) Exchange rates (200) Oil price movements (200) Returns to firm’s industry (200) Greek model (200) V1 = V(βrm + δL + ε) | Where: V =initial value; V1 = end-of-period value βrm = sensitivity to market returns δL = sensitivity to “luck” as defined by various market indices ε residual from regression
4. Methodology Looked at S&P’s ExecuComp Data, 1992-2001 (N=13,737 for total sample; n=6,263 for regression subset) Subset includes execs with 2+ yrs coverage, fiscal years ending in December (peer group performance), no mid-year CEO changes Looked at Center for Research in Security Prices (CSRP) for firm returns and volatility Followed approach of existing models (e.g. Aggarwal and Samwick, 1999a; Depart from Betrand and Mullainathan, 2001) Consider changes in compensation as function of dollar performance measures for both luck and skill Did not fix sensitivity of pay to luck or skill - does not set all executives and firm contracting equal
5. Findings For every $1000 gain in shareholder wealth (210): Skill: tot. compensation (+Δ$0.96), bonus payouts (+ Δ$0.31), new option grants (+Δ$0.42) Luck: tot. compensation (+Δ$0.74), bonus payouts (+Δ$0.18), new option grants (+Δ$0.35) For every $1000 loss in shareholder wealth (211-212; Table 5): Rewarded (+ Δ$0.79) in good luck; Punished (-Δ$0.60) Bad skill is punished more than good skill is rewarded; Bad luck is punished less than good luck is rewarded
6. Implications Principal-Agent vs. Shareholder transfer of wealth Principal-Agent predicts we should structure contracts to maximize effort, e (assuming correlation to outcome, a) Alternate view: executive compensation not determined as ex ante efficient contracting arrangement, but as way to transfer wealth from shareholders to executives ex post (224) Findings suggest asymmetry in contracting based on luck Executives are punished less (25-45%) in bad luck (per Principal-Agent theory) Executives reap greater gains for good luck (per shareholder transfer of wealth)
7. Recommendations Consistency Benchmarking should be even-handed: Should reflect greater punishments or lesser gains to optimize effort, OR Should be eliminated entirely
8. Alternate Interpretation of Findings Performance nonlinearities External labor market forces Job loss as punishment for bad luck
9. Further Exploration Better distinguish between luck and skill (207) Governance and skimming (219-222) Fixed value versus fixed number option granting policies (222-223) Rent-seeking from efficient contracting (224) Repercussions from 9/11, recessions from 2000-2010
