CEO horizon problem and characteristics of board of directors and compensation committee

• DOI: http://doi.org/10.1002/jcaf.22446
• Date: 01 October 2020
• Author: Zhenfeng Liu,Ruonan Liu
• Published date: 01 October 2020

BLIND PEER REVIEW

CEO horizon problem and characteristics of board

of directors and compensation committee

Ruonan Liu

1

| Zhenfeng Liu

2

1

University of the Pacific, Stockton,

California

2

University of Michigan-Flint, Flint,

Michigan

Correspondence

Ruonan Liu, Eberhardt School of

Business, University of the Pacific, 3601

Pacific Ave., Stockton, CA 95211.

Email: rliu@pacific.edu

Abstract

Extant research finds inconclusive evidence about the CEO horizon problem.

One possible explanation is that board of directors, especially compensation

committees, intervene to mitigate the CEO horizon problem. In this study, we

examine whether the characteristics of board of directors and compensation

committee affect their effectiveness in mitigating the CEO horizon problem.

We find that retiring CEOs are more likely to reduce R&D expenditures when

CEOs have more power, and director tenure is longer; retiring CEOs in firms

with large board of directors and compensation committee are less likely to

manage accruals.

KEYWORDS

board of directors, CEO horizon problem, compensation committee

1|INTRODUCTION

CEOs face horizon problem. That is, CEOs with

earnings-based compensation may focus on boosting

firms' short-term performance at the expense of share-

holders' long-term interests. Extant research has found

inconclusive evidence about the CEO horizon problem.

One possible explanation for the mixed findings is that

compensation committees design CEO compensation in

such way that discourages retiring CEOs from opportu-

nistic earnings management (Cheng, 2004) and R&D

reduction (Huson, Tian, Wiedman, & Wier, 2012). Board

of directors (hence the board), especially the compensation

committee, is responsibl e to adjust CEO compensati on

package to alleviate this agency problem with myopic

horizon. However, not all directors are equally effective.

This study examines whether certain characteristics of the

board and compensation committee can affect the ability

to mitigate CEO horizon problem.

To effectively mitigate CEO horizon problem, the

board and the compensation committee need to act inde-

pendently and to align the interests of CEOs with those of

shareholders. The board and the compensation committee

should be aware of CEOs' horizon problem and adjust

their compensation packages accordingly.

Using a sample of 13,606 firm-year observations for

S&P 1500 firms from 1998 to 2011, we find that both

CEO power and director tenure increase the likelihood

of R&D curtailment when CEOs approach retirement.

Wealsofindthatthesizeoftheboardandthecompen-

sation committee decreases the likelihood of accruals

management when companies face a CEO horizon

problem.

This study contributes to the literature twofold. First, we

provide further empirical evidence to echo the debate over

CEO horizon problem. Previous studies (Cazier, 2011;

Dechow & Sloan, 1991; Gibbons & Murphy, 1992;

Kalyta, 2009; Murphy & Zimmerman, 1993; Pourciau, 1993)

provide mixed evidence of the horizon problem because

they do not consider the role of board and more specifically

theroleofthecompensationcommitteeindetermining

CEO compensation package. Moreover, the study adds to

the literature on corporate governance, revealing that board

of director and compensation committees characteristics

affect the effectiveness of mitigating an organization's CEO

horizon problem.

Received: 15 December 2019 Revised: 20 March 2020 Accepted: 25 March 2020

DOI: 10.1002/jcaf.22446

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