After Jensen and Meckling (1976) present that the separation of ownership and control leading to many potential conflicts of interest between shareholders and corporate managers, many literatures have focused much attention on how to reduce agency costs and align managers‟ and shareholders‟ interests. The explosive growth in the grants of equity-based incentives (option and restricted stock grants) to corporate managers (Murphy (1999)) has motivated extensive studies of the payment structure of corporate CEOs. Defusco, et al. (1990) report that the adoption of executive stock options induces an increase in the managerial risk-taking and transfers in wealth from bondholders to stockholders. Yermack (1995) analyzes stock option awards to CEOs and indicates that companies tend to provide greater incentives from stock options when their accounting earnings contain large amounts of noise.
In addition to the change in the payment structure, the relation between managerial incentives and corporate acquisitions has long been an issue for research. Since corporate acquisitions are among the largest investments and can lead to heightened conflicts of interest between managers and shareholders, many researchers design various models to estimate the manager pay-performance sensitivities after acquisition activities. Datta, Iskandar-Datta, and Raman (2001) report a strong and positive relation existing between acquiring managers‟ equity-based incentives and acquisition performance. Bliss and Rosen (2001) show that CEOs‟ wealth and compensation usually increase after a large bank acquisition, even though the acquirors‟ stock price suffer from declining. Masulis, et al. (2009) examine how divergence between insider voting and cash flow rights affect managerial extraction of private benefits of control.
They discover that as the divergence widens, CEOs receive higher compensation and managers make shareholder value-destroying acquisitions more often. This study includes three determinants that may have impact on CEOs‟ post-acquisition
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compensation. The first determinant is firms‟ performance subsequent to acquisitions.
To further investigate post-acquisition pay-for-performance sensitivities, Harford and Li (2007) explore how compensation policies following mergers affect a CEO‟s incentives to pursue a merger. Their results show that acquiring CEO‟s pay and overall wealth become insensitive to negative stock performance, while it rises in step with positive stock performance, after conducting an acquisition. Comparing to taking major capital expenditures, CEOs are more rewarded to undertake acquisitions.
This study examines whether acquiring CEOs‟ compensation are sensitive to stock performance after an acquisition. Are CEOs unaffected from companies‟ poor performance? The answer to this doubt leads to the first hypothesis:
(H1) Acquiring CEOs’ compensation are aligned with acquiror’s post-acquisition performance. CEO earn more when the acquiring firm performs well, otherwise, CEOs suffer decline in compensation as punishment of poor performance.
If hypothesis 1 is accepted, CEOs need to take the responsibility of the acquisition.
If the performance is good, CEOs can earn more. Otherwise, CEOs suffer declines in compensation. This implies that the alignment of CEOs‟ and shareholders‟ interests exists, which is consistent with many corporate governance literatures.
In addition to acquiring firm‟s post-acquisition performance, the status of an acquisition also matters when it comes to compensating CEOs. Many literatures address the research of successfully completed transactions but only few studies focus on withdrawn acquisitions. This study includes both successful and withdrawn acquisitions to make comparison and analysis. Previous studies indicate that managers are more likely to withdraw acquisitions that generate less favorable market reactions.
(Luo(2005), Chen, Harford, and Li(2007), Paul(2007)). Masulis, et al. (2009) present that acquiring firms with higher leverage are less likely to withdraw their proposed deals. However, they do not assess the impact on CEO‟s compensation. In withdrawn deals, CEOs may be punished for poor leading skills, or CEOs may be unaffected since the withdrawn deals prevents the acquiring firms from great amount of payment. On the other hand, does a successful acquisition promise the awards for managers? Or does the extra cost of acquisition fee limit the CEOs‟ compensation?
Accordingly, the second hypothesis investigates whether the deal status (Successful
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or Withdrawn) of acquisition have impact on CEO incentives:
(H2) CEOs that complete successful acquisitions receive more incentives as their rewards for accomplishing a deal, while the CEOs compensation in withdrawn acquisitions is unaffected by the status of a deal.
Hypothesis 2 provides an assumption that CEOs‟ compensation will increase after successful acquisitions, but are not affected if the acquisitions are withdrawn.
Although in withdrawn cases, CEOs may be punished for poor leading performance, the acquiring firms simultaneously prevent a large amount of payment, which may be an increasing factor of CEOs‟ payment. Thus this study suggests that CEOs‟
compensation is not affected if the acquisitions are withdrawn.
Many academic researches show that bid characteristics play an important role in acquisition assessment. Hayward (2002) employs different bid characteristics, such as relative acquisition size, contested bid, cash payment, and use of advisor, to examine whether acquisition experience contributes to the following acquisition performance.
To further investigate the factors that may affect CEOs compensation in an acquisition situation, this study includes cash payment, the use of advisor, and relative deal size as the bid characteristics variables to generate the following hypotheses:
(H3.1) Cash payment acquisitions have negative impact on CEO incentives. CEOs receive less compensation after the acquisition if the payment method is merely in cash.
Cash payment acquisition is defined as the acquisition that provides 100% cash offer to the target firm. If the method of payment includes stock payment or a combination of cash and stock, then it is not categorized as Cash Payment. Loughran and Vijh(1997) suggest that stock financed acquisitions generated significantly lower returns than cash financed ones. However, this study focuses on the substantial cash outflow in acquisition deals, which may negatively affect CEOs‟ compensation. The hypothesis 3.1 thus presents a negative relation between cash payment and CEOs‟
compensation.
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(H3.2) The use of advisor helps increasing CEO compensation since the advisors can provide professional assistance and enhances the feasibility and profitability analysis when undertaking an acquisition. These may generate the more incentives for CEOs.
Hypothesis 3.2 shows the use of advisor may enhance CEOs‟ compensation. Since hiring professional advisors generally provide the acquisition with better and facilitated evaluation, acquiring firms may award CEOs for making the decisions of using advisors. Thus the hypothesis suggests a strong positive relation between CEOs‟
compensation and the use of advisor.
(H3.3)Relative deal size is negatively related to CEO payment. Since the disgorgement of acquiror’s fund may be unbalanced, the larger the relative acquisition size, the fewer the CEOs compensation.
Relative deal size is the final purchase price of the acquisition as a percentage of the market capitalization of the acquiring firm at the time of acquisition announcement. Thus, relative deal size counters for the importance of the deal. If the relative size ratio is large, the acquiring firm tolerates higher pressure of the acquisition. In the mean while, the fund requirements of acquisitions with high relative deal ratio may result in negative influences on CEOs‟ compensation.
Hypothesis 3.3 depicts that CEOs who conduct acquisitions with larger relative deal sizes may suffer compensation declines.
Moreover, the relation between corporate governance and CEOs compensation has long been discussed from many literatures. Core, et al. (1999) show that there is an association between the level of CEO compensation and corporate governance. They suggest that firms with weaker governance have greater agency problems and CEOs in such companies may extract greater compensation. Harford and Li (2007) report similar result that bidding firms with stronger boards retain the sensitivity of their CEOs‟ compensation to poor performance following the merger. Basu, et al. (2007) point out that top executive pay is higher in firms with weaker corporate governance mechanism in Japan.
Corporate governance does matter when it comes to executive payment while the
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method of corporate governance evaluation varies. Gumpers, Ishii, and Metrick (2003) construct a broad index, G-index, of antitakeover provisions with five governance rules (delay, protection, voting, state, and other) for a total of 24 possible provisions.
Higher G-index value represents that the shareholders have lower power in comparison with managers, and vice versa. This study employs G-index as the proxy of corporate governance to evaluate the change of CEOs compensation after an acquisition. Thus, the fourth hypothesis is developed as follows:
(H4) CEOs receive more incentives after an acquisition if the acquiring firms have higher G-index, that is, with weaker corporate governance mechanism. On the contrary, acquirors with lower G-index compensate more to their CEOs.
In hypothesis 4, G-index provides the link between corporate governance mechanism and CEOs‟ compensation. Acquiring firms with lower G-index are less likely to compensate their CEOs with substantial incentives after the acquisition due to the better quality of corporate governance mechanism. On the other hand, acquiring CEOs can earn more if the acquiring companies have higher G-index since CEOs have much power compared to shareholders‟ in these situations.
III. Sample and Empirical Design