Charitable inclination and the chief executive officer's pay package

• Date: 01 February 2021
• Author: Dev R. Mishra
• Published date: 01 February 2021
• DOI: http://doi.org/10.1111/fire.12241

DOI: 10.1111/fire.12241

ORIGINAL ARTICLE

Charitable inclination and the chief executive

officer’s pay package

Dev R. Mishra

Edwards School of Business, University of

Saskatchewan, Saskatoon, Canada

Correspondence

DevR. Mishra, Edwards School of Business,

Universityof Saskatchewan, 25 Campus Drive,

Saskatoon,SK S7N5A7, Canada.

Email:Mishra@edwards.usask.ca

Abstract

Using chief executive officers’ (CEOs’) lifetime nonemploy-

ment experience in prominent charitable organizations to

create a proxyfor CEO charitable inclination, I find that char-

itably inclined CEOs receive a significant pay premium. The

pay premium sensitivity to CEO charitable inclination is par-

ticularly pronounced for male, external, and specialist CEOs

who are employed at firms that are undiversified, larger,less

debt reliant, poor performing, facing high product-market

competition, and that keep nonmanipulative financial state-

ments and demonstrate high inclination to social responsi-

bility in the area of diversity,employee relations, and internal

governance.This research contributes to the broader debate

on labor market pricing of CEO characteristics.

KEYWORDS

CEO pay, charitable inclination, corporate social responsibility,

nonemployment experience

JEL CLASSIFICATION

G3, M1, Z

1INTRODUCTION

Theoretical literature on chief executiveofficer (CEO) pay that relies on the firm value maximization perspective sug-

gests that the optimal CEO compensation is an outcome of the CEO labor market competition. Under this perspective,

in executing CEO compensation contracts, corporate boards are likelyto account for CEOs’ skills and abilities that

may haveimplications for firms’ productivity and performance (e.g., Edmans, Gabaix, & Jenter, 2017; Edmans, Gabaix,

& Landier,2009; Gabaix & Landier, 2008;Murphy&Zábojník,2004, 2007; Terviö, 2008). This view suggests that CEO

pay is a function of a firm’s outside options (i.e., supply of CEOs with desired skills in the labor market) and a CEO’s

outside options (i.e., the labor marketdemand for CEOs’ skills; e.g., Edmans et al., 2017). At the center of this literature

Financial Review. 2021;56:85–108. wileyonlinelibrary.com/journal/fire ©2020 The Eastern Finance Association 85

86 MISHRA

is the belief that there are vital distinctions in CEOs’ skills, abilities, education, and connections that have implications

for their contribution to firms’ productivity and that a variation in such skills attracts a meaningful variation in CEO

pay (e.g., Custódio, Ferreira,& Matos, 2013; Engelberg, Gao, & Parsons, 2013; Falato, Li, & Milbourn, 2015). Empirical

research on the determinants of optimal compensation contracts has largely focused on some readily available firm,

industry,and market characteristics to generate proxies for such CEO features. The identification of direct measures

of CEOs’ productive skills and abilities has been a significant challenge. In this research, I make one such attempt by

creating a proxy reflecting CEO charitable inclination and by showing that CEO pay is an increasing function of this

proxy.

There are a modest number of recent empirical efforts that use more direct proxies of a CEO’s abilities/skills and

show that CEO pay,especially the size of CEO compensation, accounts for such abilities and skills. These studies rely

on CEOs’ biographical information, such as education, work experience, past CEO/executive experience, the variety

in work experience, and outside connections, to create proxiesfor CEOs’ skills and abilities. For example, Falato et al.

(2015, p. 2845) “code detailed biographical information for a large sample of CEOs to identify specific CEO charac-

teristics that on a priori grounds are indicative of skills” and show a positive pay premium for such skills. Falato et al.

(2015) rely on press, fast-trackcareer, and selective schooling to generate a proxy for productive CEO talent. Custódio

et al. (2013) create a proxy of general managerial skills based on CEOs’ lifetime work experience and show a signifi-

cant pay premium for generalist CEOs compared to that for specialist CEOs. This literature argues that as such skills

are portable across firms, they improve CEOs’ bargaining power and attract a pay premium. Engelberg et al. (2013,

p. 80) create a measure that ranks “CEOs by their personal associations with high-ranking executivesor directors at

other firms” and call the measure the “CEO’s Rolodex.” They find that CEOs who rank higher in their connectedness

receive a higher pay. However, this empirical literature focuses particularly on the features that may have implica-

tions for the productive skills and abilities of managers. Recent literature on CEO attributes also suggests that other

characteristics, such as CEOs’ attitude to risk taking, CEOs’ inclination to corporate social responsibility (CSR), and

CEOs’ belief system, may haveimplications for firm-level outcomes, because they shape CEOs’ psychological makeup.

For example,Roussanov and Savor (2014) investigate the effect of CEOs’ marital status on their attitude toward cor-

porate risk taking, Nicolosi and Yore(2015) study the effect of marital status in unobservable risk preferences using

corporate deal making, Cronqvist and Yu(2017) examine the effects of parenting daughters on CEOs’ attitude toward

CSR, and Hegde and Mishra (2019) show firms managed by married CEOs are more CSR intensive.

What I note, however, is that none of the empirical research has utilized CEOs’ charitable inclination as revealed

from their past actions and estimated its association with CEOs’ compensation. The measurement of human psycho-

logical orientation, such as charitable inclination, is at least as difficult as the measurement of human skills and abili-

ties. Past literature has relied on things such as executiveoptions or media presence to measure CEOs’ psychological

characteristics, such as CEO hubris or overconfidence (e.g., Hirshleifer,Low, & Teoh, 2012; Malmendier & Tate, 2005,

2008; Tang,Qian, Chenm, & Shen, 2015). Because the literature on volunteerism suggests volunteering demonstrates

a strong passion for a cause that reflects personal interests (Conn & Barr, 2006) and because the choice for nonem-

ployment activity, among other things, is a function of an opportunity to “act on and expressdeeply held values” of

an individual and a feeling of self-esteem (Clary, Snyder, & Ridge, 1992), I believe past nonemployment experience

in charitable organizations reflects a CEO’s charitable inclination. In this paper I use CEOs’ lifetime nonemployment

experience to code a novel proxyrepresenting CEOs’ innate appreciation for social and charitable work (which I call

CEO charitable inclination) and show such charitable inclination attracts a significant pay premium for CEOs. This

study’s focus is on the experience that is driven byCEOs’ passion for social good (i.e., nonemployment) rather than on

the standard economic reasons (e.g.,an employment to earn a living), and I attempt to explain why such CEO charitable

inclination attracts significant pay premium.

Iask a simplequestion: Does CEOs’ charitable inclination matter in designating compensation contracts in the labor

market for CEOs? If it does, why is there a pay premium for reportedly charitably inclined CEOs? The fundamen-

tal guiding principle of this research relies on the competitive sorting theory of labor market, as Falato et al. (2015,

p. 2846) point out “that boards of directors and their search consultants evaluate CEO skills by relying at least in part