CEO Tenure, Market Competition, and Sticky Pay‐without‐performance as the Extraction of Rents

• DOI: http://doi.org/10.1111/ajfs.12169
• Author: Daecheon Yang,Minyoung Lee,Jinbae Kim
• Date: 01 April 2017
• Published date: 01 April 2017

CEO Tenure, Market Competition, and

Sticky Pay-without-performance as the

Extraction of Rents

Jinbae Kim

Korea University Business School, Republic of Korea

Daecheon Yang*

School of Business Administration, Chung-Ang University, Republic of Korea

Minyoung Lee

Korea University Business School, Republic of Korea

Received 26 August 2016; Accepted 29 December 2016

Abstract

This study examines the undesirable impact of CEO tenure on downwardly sticky pay, and

the moderating effect of higher market competition on the potential adhesive connection

between CEO tenure and sticky pay. We find that CEO pay stickiness intensifies as CEO

tenure increases. This suggests that entrenched executives extract greater levels of baseline

rents through strong exclusivity. In contrast, we find that in firms with long-tenured CEOs,

higher levels of competition intensity alleviate CEO pay stickiness. These results imply that

although long-tenured CEOs tend to exert a powerful influence over the pay-setting process,

increased competition restrains CEOs’ rent-seeking behavior.

Keywords CEO tenure; Market competition; Sticky CEO pay; CEO power

JEL Classification: G34, J33, M41, M52, L1

1. Introduction

The literature on CEO tenure documents that as the duration of CEO tenure

increases, a CEO becomes entrenched with lower termination risk, thus influencing

the board’s pay-setting process (Chung and Pruitt, 1994; Lee and Chen, 2011; Abed

et al., 2014; Van Essen et al., 2015). Conversely, prior research describes that higher

market competition increases both the likelihood of a firm’s liquidation and the risk

of a CEO’s dismissal, thereby forcing an entrenched CEO into a defensive stanc e

(DeFond and Park, 1999; Bebchuk and Fried, 2004). Relevant to these matters, our

*Corresponding author: Daecheon Yang, Associate Professor of Accounting, School of Busi-

ness Administration, Chung-Ang University, 84, Heukseok-ro, Dongjak-gu, Seoul 06974,

Korea. Tel: +82-2-820-5459, Fax: +82-2-815-7001, email: dcyang@cau.ac.kr.

Asia-Pacific Journal of Financial Studies (2017) 46, 246–275 doi:10.1111/ajfs.12169

246 ©2017 Korean Securities Association

study focuses on a firm’s condition “without performance,” where a CEO’s

entrenchment may severely hurt the firm. Thus, we explore not only whether long-

tenured CEOs adhere to pay-without-performance as a means of rent extraction,

but also whether higher market competition—as a corporate governance mecha-

nism—mitigates their unconditioned rent-seeking behavior.

Traditional agency theorists emphasize the role of pay-for-performance in align-

ing the interests of management and shareholders (e.g., Jensen and Meckling, 1976;

Holmstr€

om, 1979; Grossman and Hart, 1983; Jensen and Murphy, 1990; Murphy,

1998; Core et al., 1999).

1

However, the literature on CEO power theory describes

how some pay arrangement features, rather than efficiently incentivizing CEOs,

seem to reflect CEOs’ rent-seeking (e.g., Blanchard et al., 1994; Yermack, 1997; Ber-

trand and Mullainathan, 2001). In particular, a hotly discussed stream of literature

shows that in the business world, a CEO’s pay is downwardly sticky—that is, a

CEO’s annual pay increases when a firm’s performance increases, but it does not

decrease to the same extent if the firm’s performance declines (Gaver and Gaver,

1998; Adut et al., 2003; Garvey and Milbourn, 2006; Jackson et al., 2008; Fang,

2009; Wenliang et al., 2011; Chen et al., 2014a).

Moreover, the literature on CEO tenure emphasizes the importance of the dura-

tion of CEO tenure, suggesting that CEO tenure strongly relates to entrenchment (Hill

and Phan, 1991; Hermalin and Weisbach, 1998; Allgood and Farrell, 2000; Almazan

and Suarez, 2003; Boone et al., 2007; Ryan et al., 2007; Brookman and Thistle, 2009;

Zheng, 2010; Dey and Liu, 2011; Cook and Burress, 2013; Dikolli et al., 2014). The lit-

erature posits that long-tenured CEOs may become entrenched because they can

influence the nomination of incoming board members and, thus, the board composi-

tion; this could result in a board that is loyal to and cooperates with the CEO. Above

all, as CEOs become entrenched in their position, they are expected to have more

power over the pay-setting process. The literature reports that a CEO’s pay structure

becomes corrupted with the length of tenure due to a reduced risk of termination.

Related studies find that long-tenured CEOs receive higher pay (Chung and Pruitt,

1994; Lee and Chen, 2011; Abed et al., 2014; Van Essen et al., 2015). In particular,

Bebchuk and Fried (2004, 2006) note that when CEOs have power over the board, we

would expect executives to receive higher pay, irrespective of their performance.

In contrast, the literature on market competition documents that market competi-

tion may increase the likelihood of liquidation, thereby forcing CEOs into a defensive

stance. DeFond and Park (1999) show that the level of industry competition is a cru-

cial factor for the frequency of CEO turnover. Bebchuk and Fried (2004) posit that

1

According to the optimal contracts theory—which is in turn based on agency theory (e.g.,

Jensen and Meckling, 1976; Holmstr€

om, 1979; Grossman and Hart, 1983; Jensen and Mur-

phy, 1990; Murphy, 1998; Core et al., 1999)—optimal pay-for-performance arrangements

indeed induce executives to make their best efforts, thereby ensuring shareholder wealth.

Such arrangements are expected to be based on a fair trade platform between the board and

the executives.

CEO Tenure, Market Competition, and Sticky Pay

©2017 Korean Securities Association 247