The determinants of executive compensation packages are fraught with empirical difficulties due to unobserved firm-level, CEO-level, and assortative matching characteristics. In the paper “Managerial Attributes, Incentives, and Performance,” just published in the August 2020 issue (Volume 9, Issue 2), Jeff Coles and Frank Li examine the relative importance of observable and unobservable firm- and manager-specific characteristics in determining two fundamental attributes of executive incentives, delta and vega. They find that manager fixed effects, that can capture managerial talent and risk aversion, account for a very significant portion of the variation in these executive incentives. This result is important because it sheds light on the limitations of empirical investigation on executive compensation so far: it is hard to find appropriate and comprehensive measures of these managerial characteristics among the observable managerial characteristics used in the existing literature. Jeff and Frank also find that managerial fixed effects of these compensation incentives could explain future firm policy, risk, and performance. It is quite surprising that some established relationships between executive incentives and firm outcomes are indeed driven by the manager-fixed-effects portions of delta and vega only. Importantly, the significant relative explanatory power of unobserved managerial heterogeneity found in this paper would suggest that both theoretical and empirical work will benefit from focusing on the roles and attributes of top managers.
Spotlight by Andrew Ellul
Photos courtesy of Jeffrey L. Coles and Zhichuan (Frank) Li