Essays in Executive Compensation

This doctoral thesis is made of three empirical research papers focused on executive compensation topics. The first chapter is a solo paper, while the second and third papers are co-authored with Antonio Parbonetti. The first chapter answers to Bushman and Smith’s (2001) call for research on compensation of executives other than CEOs. Specifically, using a sample of 586 firm-year observations over the period 2000-2009, I investigate the economic determinants and effects on shareholder value of the equity incentives given to the Chief Marketing Officer (CMO). The paper shows that, when companies invest more in marketing activities, they also give the CMO more equity incentives. I also find that CMOs’ equity incentives are positively related to shareholder value and that this positive relationship is incremental to that between CEOs’ incentives and firm value. Finally, I document that the positive impact of CMOs’ equity incentives on firm value is not limited to those firms that invest more than the industry average in marketing, suggesting a strategic role for the CMO that is not linked only to the size of the marketing budget. These findings, which help to advance our understanding of the determinants and effects of executive compensation, have considerable practical implications. Specifically, I challenge the mainstream view that the CEO’s compensation captures all first-order effects and that the consequences of the compensation structure of executives other than the CEO are negligible. In fact, I document that the Chief Marketing Officer plays a central role in delivering shareholder value when she is properly incentivized. I also show that companies do not simply rescale the CEO’s incentives when they decide how to incent the CMO, but they take a proactive role in detecting other economic determinants in order to set the appropriate level of incentives. Therefore, findings reported in the paper warn companies not to focus only on setting the CEO’s incentives, while neglecting to incent other key top executives such as the CMO. The second chapter, instead, analyzes how CEO’s equity incentives, risk incentives and career concerns drive the trade-off among earnings game strategies. Accounting literature documented that managers, in order to meet earnings targets, may engage in the numbers game by making choices among three non mutually exclusive strategies. Specifically, executives can alter reported earnings through real or accrual earnings management, and/or guide analysts’ expectations downward in an attempt of avoiding negative earnings surprises. Previous literature showed that stricter regulation (i.e. the passage of the SOX), and firm’s specific characteristics, influence the relative costliness of each earnings game strategy (Cohen et al., 2008; Zang, 2012). Nonetheless, literature fails to recognize that earnings game strategies are decided and executed by the CEO, who is going to consider, in the choice of how meeting/beating targets, also her personal costs and benefits. Using a sample of 4,471 quarterly observations, from 1,088 U.S. firms that are likely to have engaged in the earnings game over the period 2003-20010, I show that CEOs trade off the different earnings game strategies according to their personal benefits and costs. Specifically, I find that CEOs with high equity incentives and high career concerns engage less in real activity manipulations than executives with low incentives, and substitute this earnings game strategy with other alternatives. Additionally, I document that firms using real activity manipulation to meet/beat targets have lower future market performances than firms using accrual earnings management or analysts’ guidance. This result indicates that earnings game strategies that mostly rely on the alteration of real activities, impose very high costs on shareholders. CEOs appear to understand and anticipate this effect and, when their interests are aligned with those of shareholders in terms of equity incentives and career concerns, they avoid to choose real earnings management strategies. Overall, this chapter contributes to a well established research stream such as earnings management, by analyzing the trade-off among earnings game strategies from a new prospective. Finally, the last chapter focuses the attention on CEO’s compensation in the financial industry, which has attracted an increasing interest in recent years. In fact, executive compensation has been blamed of being one of the most fundamental causes of the recent credit crisis, providing CEOs with incentives to take too many big bets that turned out to be extremely costly (Solomon and Paletta, 2009). Specifically, the paper investigates the role of CEO’s equity and risk incentives in boosting securitizations in the financial industry and in motivating executives to reduce the perceived risk while betting on it. Using a sample of US financial institutions over the period 2003-2009, the paper documents that CEOs with high equity incentives have systematically engaged in securitization transactions to a larger extent than CEOs with low incentives. It also shows that CEOs with high equity and risk-related incentives engaged in risky securitization activities and used securitization for transferring risks to outside investors. Finally, the paper shows that executives incentivized on risk provided outside investors with low quality disclosure about losses recorded on securitized loans, thus contributing to increase the opacity of securitization transactions undertaken. Overall, I interpret these results as evidence that CEOs foresaw in securitizations under US GAAP an opportunity for hiding risks while bearing them and generating profits and cash flows because of the risks. In additional analyses, I document that before the collapse of the subprime mortgage market in 2007, financial institutions involved in the securitization of subprime loans largely over performed other banks in terms of market returns and earnings. On the contrary, starting from 2007 subprime securitizers have recorded worse performances than other financial institutions that were not involved in subprime securitization. This indicates that, by securitizing risky loans, CEOs were successful in boosting stock price and earnings, but the risks undertaken turned out to be extremely costly. This paper, therefore, adds to the large stream of research warning about possible side effects of equity compensation, and uncovers a determinant of securitization transactions that has been overlooked by previous literatur

Does pay for performance work in public organizations? Empirical evidence from Italy

The purpose of the paper is to investigate the relationship between pay-for-performance compensation and organisational performance in the setting of Italian local governments. Pay-for-performance systems have been introduced in the majority of the OECD’s countries as part of their performance management systems, but research on their effects is still in its infancy. This study contributes to filling this gap by using a sample of Italian local governments to empirically determine whether variable compensation translates into higher future performance. The research methodology uses a unique hand-collected database. The study uses the measures of the local governments’ performance defined along six key dimensions (standard of living, services and environment, employment level, law and order, population, leisure), over the period 2010-2013, provided by an independent source. Detailed data on managers’ compensation for each local government is obtained from Italy’s Treasury Department, and other variables on local governments were hand collected by official documents. A multivariate analysis is conducted on 398 observations. The main results show a positive association between future performance and the percentage of variable compensation granted to local managers. Moreover, additional analyses show that this result is not driven by managers’ total compensation but it depends on the composition of managers’ compensation. Overall, empirical evidence reported in this study suggests that public organisations might benefit from the introduction of pay for performance systems.</jats:p

When LIBOR becomes LIEBOR : reputational penalties and bank contagion

We study whether commonality of incentives and opportunity to commit fraud trigger reputational contagion from culpable firms to nonculpable firms. Relying on a sample of 30 banks involved in fixing the London Interbank Offered Rate (LIBOR) and a control sample of 30 banks, we find that banks' reputations suffered substantial damage upon the announcement of their involvement in the scandal. We also document reputational contagion spread from banks that manipulated LIBOR to banks that shared the same incentives and opportunity to commit the fraud. The reputational contagion is more pronounced for large derivatives dealers who have had the strongest incentive to commit the fraud

ceo risk incentives and real earnings management

Previous research shows that companies use option compensation to motivate managers to accept risk (Jensen &amp; Meckling, 1976). Indeed, risk adverse CEOs are likely to accept less risk than that accepted by diversified shareholders (Fama &amp; French, 1992). Nonetheless, not all risks produce the expected benefits and risk has an intrinsic cost, such as potential large losses, that cannot be eliminated. Therefore, given CEO risk incentives, real earnings management can be viewed as a mechanism used to avoid the undesirable consequences of risk on reported earnings. However, engaging in real earnings management requires cutting investments, such as R&amp;D, that have a well-documented association with firm's future risk profile (Comin &amp; Philippon, 2005). As a consequence, the use of real earnings management by CEOs with high-risk incentives as a tool for mitigating the intrinsic costs of risk is an empirical question that we tackle in this paper. Using a sample of quarterly observations from US firms over the period 2003-2010, and an instrumental variable approach to overcome endogeneity concerns, we show that CEOs with high risk-related incentives engage less in real activity manipulations that encompass cutting discretionary expenditures than do executives with low incentives. These findings are consistent with the idea that CEOs incentivized on risk avoid engaging in real management activities that can decrease firm's future risk profile.</p

The impact of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 Repo ‘Safe harbor’ provisions on investors

The Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) of 2005 significantly expanded the exemptions from the normal workings of the U.S. Bankruptcy Code. Using a large sample of U.S. banks, we study investors’ reaction to news about the promulgation of the BAPCPA repo ‘safe harbor’ provisions and the influence extending such exemptions to repos collateralized by riskier collateral had on equity market information asymmetry. We find a negative market reaction to news events about the promulgation of BAPCPA, which subsequent cross-sectional analysis suggests is at least partly driven by repo exposure. This finding suggests that investors perceived the increase in finance risk from the extension of the ‘safe harbor’ provisions as dominating the perceived gain from accessing cheaper finance. Further, we find that the promulgation of BAPCPA gave rise to increased information asymmetry for banks with repo exposure

Does branch religiosity influence bank risk taking?

Using branch-level data on public and private US banking institutions, we investigate the importance of branch religiosity in shaping bank risk-taking behavior. Our results show robust evidence that branch religiosity is negatively related to bank risk-taking. This effect persists after controlling for several bank-level and county-level variables that might correlate with religiosity. Moreover, this result is robust to controlling for headquarter religiosity, suggesting that the effect of branch religiosity is additive and not washed out by headquarter religiosity. Overall, our findings document that headquarter religiosity does not capture the full effect of religiosity on bank behavior, as claimed by previous research, but that the religiosity of the geographic area in which the bank operates significantly influences bank behavior

Does social capital constrain firms’ tax avoidance?

Purpose This paper aims to investigate whether the level of social capital of the region in which a firm is headquartered affects its tax avoidance activities. Social capital can be defined as the mutual trust in society and literature shows that firms headquartered in high social capital regions exhibit higher level of corporate social responsibility. Recent research suggests that some stakeholders consider tax avoidance as a socially irresponsible and illegitimate activity, whereas others deem corporate tax payments as detrimental to social welfare because they hurt economic development. Building on this debate, the relationship between social capital and tax avoidance is empirically investigated. Design/methodology/approach A sample of 52,962 firm-year observations over the period 1990-2014 was used to empirically investigate the relationship between social capital and tax avoidance. Findings Consistent with the idea that managers consider corporate tax payments as a socially responsible action, evidence was found that firms headquartered in areas with high social capital engage significantly less in tax avoidance activities. It was also documented that the negative impact of social capital on tax avoidance is stronger in the presence of high religiosity, high corporate performance and lower sensitivity of CEO’s compensation to stock volatility. Originality/value This paper extends research on social capital and improves the understanding of the effect of the social environment on managerial decision. Importantly, by studying the relationship between social capital and tax avoidance, the authors add to the recent debate on companies’ perception of the desirability of tax avoidance activities from a social viewpoint

AlPaCas: allele-specific CRISPR gene editing through a protospacer-adjacent-motif (PAM) approach

Gene therapy of dominantly inherited genetic diseases requires either the selective disruption of the mutant allele or the editing of the specific mutation. The CRISPR-Cas system holds great potential for the genetic correction of single nucleotide variants (SNVs), including dominant mutations. However, distinguishing between single-nucleotide variations in a pathogenic genomic context remains challenging. The presence of a PAM in the disease-causing allele can guide its precise targeting, preserving the functionality of the wild-type allele. The AlPaCas (Aligning Patients to Cas) webserver is an automated pipeline for sequence-based identification and structural analysis of SNV-derived PAMs that satisfy this demand. When provided with a gene/SNV input, AlPaCas can: (i) identify SNV-derived PAMs; (ii) provide a list of available Cas enzymes recognizing the SNV (s); (iii) propose mutational Cas-engineering to enhance the selectivity towards the SNV-derived PAM. With its ability to identify allele-specific genetic variants that can be targeted using already available or engineered Cas enzymes, AlPaCas is at the forefront of advancements in genome editing. AlPaCas is open to all users without a login requirement and is freely available at https://schubert.bio.uniroma1.it/alpacas

IL-21 is a major negative regulator of IRF4-dependent lipolysis affecting Tregs in adipose tissue and systemic insulin sensitivity.

Obesity elicits immune cell infiltration of adipose tissue provoking chronic low-grade inflammation. Regulatory T cells (Tregs) are specifically reduced in adipose tissue of obese animals. Since interleukin (IL)-21 plays an important role in inducing and maintaining immune-mediated chronic inflammatory processes and negatively regulates Treg differentiation/activity, we hypothesized that it could play a role in obesity-induced insulin resistance. We found IL-21 and IL-21R mRNA expression upregulated in adipose tissue of high-fat diet (HFD) wild-type (WT) mice and in stromal vascular fraction from human obese subjects in parallel to macrophage and inflammatory markers. Interestingly, a larger infiltration of Treg cells was seen in the adipose tissue of IL-21 knockout (KO) mice compared with WT animals fed both normal diet and HFD. In a context of diet-induced obesity, IL-21 KO mice, compared with WT animals, exhibited lower body weight, improved insulin sensitivity, and decreased adipose and hepatic inflammation. This metabolic phenotype is accompanied by a higher induction of interferon regulatory factor 4 (IRF4), a transcriptional regulator of fasting lipolysis in adipose tissue. Our data suggest that IL-21 exerts negative regulation on IRF4 and Treg activity, developing and maintaining adipose tissue inflammation in the obesity state

The performance of the Italian housing market and its effects on the financial system

Developments in the real-estate sector are of crucial importance for the business cycle and financial stability. This study analyses developments in the Italian housing market on the basis of both real and financial variables. Following the sharp contraction of the market during the financial crisis and the more general fall in economic activity, a few signals suggests that the recession in the housing market is easing somewhat. However, the degree of uncertainty remains considerable. In recent months the ratio between the flow of bad debts to total outstanding loans to households and construction firms has reached the highest levels since the beginning of the decade. The paper also investigates three issues of a more structural nature. First, it examines the performance and the regulatory framework of real-estate investment funds in Italy. Second, it analyses the main characteristics of the taxation of residential housing, with reference to ownership, rentals and transactions. Finally, the paper estimates the impact on residential house prices of the growing demand for housing services by immigrants.housing market cycle, transactions, rentals, residential house prices, mortgages, real-estate investment funds, taxation of residential housing