# Presentation: 521165

## Pay for Performance?CEO Compensation and Acquirer Returns in BHCs

- Kristina Minnick, Bentley College
- Haluk Unal, University of Maryland and FDIC CFR
- Liu Yang, UCLA

## CEO Compensation in BHCs

**Notes:**
The CEO compensation in BHCs has increased dramatically in the past decade. In 1992, an average CEO received 2.7 million in total compensation, among which, $1.2m is in cash. In 2005, an average CEO receives $5.1m, among which, $2.1m is in cash. The percentage of cash (stocks and options) used in compensation is also decreasing (increasing) over time. In later 90s and early 2000, less than 50% of the compensation is paid in cash, as compared to over 60% in early 90s.

## Pay-for-Performance Sensitivity

- Change of the CEO's wealth (in $000s) given a 1% change in stock price

**Notes:**
In the meantime, the connection between the CEO’s personal wealth and the BHC’s stock price becomes stronger and stronger. The pay-for-performance sensitivity in CEO pay quadrupled in the past 13 years - In 2004, on average, a 1% increase in stock price brings in more than $800,000 for the CEO in her personal wealth, as compared to less than $200,000 in 1992.  Stock grants constitute about 56% of the PPS, while option grants contributes to 44%

## Histogram of PPS

**Notes:**
The use of incentive-based compensation also differs across different bank holding companies. In our sample, about 6% of the banks have PPS less than $20,000 (log=3), and about 14% of the banks have PPS greater than $1m (log=7) – The average is about $500,000.

## CEO with the Highest Total Compensation (by Year)

**Notes:**
This list shows the CEO with the highest total compensation by year and their rank based on PPS. Two things are note-worthy. 
First, there seems to exist a size effect – bigger banks tend to have both high compensation and high PPS. Most of the banks on the list are indeed larger ones. For example, Bank of America, JP Morgan, Wells Fargo.
Second, high compensation does not necessarily mean high PPS. For example, in 1996, Bankers Trust’s CEO received $11m in his total compensation, making him the third highest paid CEO, while for the same period, his PPS is about $100,000 which is far below the average.

## Our Paper

- Research Question
- Does higher pay-for-performance sensitivity (PPS) lead to value-enhancing managerial effort?
- Application
- Mergers and acquisitions
- Tests
- Decisions to acquire
- Market reaction: announcement returns to stock- and bond-holders
- Change of operating performance after mergers

**Notes:**
In this paper, we ask the following question – does high pps help to eliminate the agency problem and lead to value-enhancing managerial effort?
The application we chose is mergers and acquisitions. Among all the decisions a CEO makes, acquisitions have probably the most significant impact on shareholder value. 
Banks provide a natural experiment to study merger decisions for the following reasons:
First, the banking industry has gone through a rapid consolidation in the past two decades, allowing us to collect a large number of events.
Second, the industry itself is very homogenous, and most of banks only operate in financial industry. Therefore acquisitions are not driven by diversification.
To examine the role of CEO compensation in mergers, we look at three things
First, we investigate how PPS affect a CEO’s decision to acquire – are banks with high PPS more or less likely to take acquisitions?
Second, does market react differently to acquisition announcements made by banks with high PPS? Besides returns for stock-holders, we study returns for bond holders as well, considering the possibility that strong alignment of CEO’s wealth to stock price may make CEO take actions to benefit sharesholders at the expense of bond-holders. 
To examine the real impact of acquisitions, we also look at changes of operating performance for acquirer banks after the merger.

## Related Literature

- Corporate governance and acquisitions
- Datta, Iskandar-Datta, and Raman (2001)
- Harford and Li (2007)
- Falato (2007)
- Masulis, Wang, and Xie (2007)
- Governance in banks
- Bliss and Rosen (2001)
- John, Mehran and Qian (2007)
- Adams and Mehran (2003)

**Notes:**
 Our paper is related to the literature that studies the role of governance in merger decisions, and especially papers that look at the impact of governance in the banking industry. 
The empirical findings are mixed. 
For example, DIDR find a strong positive relation between acquiring mangers’ equity-based compensation (EBC) and merger performance. 
While Harford and Li provide evidence that CEOs are generously awarded with new stock and option grants after acquisition even when shareholders are worse off. Therefore, these new grants can eliminate any incentive effect provided by the CEO’s pre-acquisition portfolio. 
Falato has a paper that is closest to our research – He shows that ...
On banks,
Bliss and Rosen show that banks in which CEO has high incentive-based compensation are less likely to take acquisitions
A recent paper by JMQ finds that PPS is higher when banks have low leverage and face more intensive external monitoring. Idea: trade-off between risk-shifting and shirking

## Our Data

- Completed acquisitions in the banking industry as identified from the SDC Platinum in the period of 1990 to 2005
- Data available
- Financial data from Compustat Bank and Call Reports
- Stock prices from CRSP
- Compensation data from ExecuComp
- Final sample
- 178 deals made by 65 acquiring BHCs
- The control sample contains 700 bank-years that are not related to M&A
- Robustness check
- Comprehensive governance dataset with: board structure, anti-takeover provisions, and institutional ownership
- Bond return data from LBBD

**Notes:**
We begin with all completed acquisitions in the banking industry with announcement date between Jan. 1990 and Dec. 2005 as identified from SDC Platinum.
Then, we require bidders have financial data from compustat bank, or call reports; stock data from CRSP and compensation data from execucomp.
To study decisions to acquire, we also construct a control sample, that contains 700 bank-years not related to acquisitions.
We built a comprehensive governance dataset for our sample banks that contain information on board structure, anti-takeover provisions and institutional ownership. We use Lehman Brothers’ Bond Database to collect bond return data. 

## Probability to Acquire (Table IV)

- Dependent Variable:
- 1: Acquire=Y
- 0: Acquire=N

## Probability to Acquire

- Banks with low PPS are more likely to acquire, controlling for other characteristics
- Banks in the first quartile of PPS are 24% more likely to acquire as compared to banks in the last quartile
- Moving from high-PPS group (mean + stdev) to low-PPS group (mean – stdev) lowers the acquisition probability by 37%

## Acquirer Announcement Returns

**Notes:**
We use both the 3-day and 5-day event window to study the announcement return for shareholders. Both returns are widely dispersed, and slightly positive on average. (returns are higher for 95 and 2000 period)

## Acquire Returns by PPS Group

- The difference in CAR between Low- and High-PPS group is 71bps.

## Stock Returns (Table 7)

- One standard deviation increase of PPS will increase CAR by 0.51%

- Dependent Variable: CAR(-1,1)

**Notes:**
Our multivariate analysis shows consistent results. We find positive and significant coefficients for all of our PPS measures. One standard deviation increase of total PPS will increase CAR by 51 bps

## Bond Returns (Table 9)

- Dependent Variable: BAR(-1,1)

- High PPS also benefits bond-holders!

**Notes:**
Does high PPS give CEO incentive to take actions to benefit shareholders but at the expense of bondholders? No! Bondholders also benefit from incentive-based compensation. Using a three-month event window (only monthly bond data is available), we find a positive and significant relationship between acquirer CEO’s pre-acquisition PPS and announcement return for bond holders.

## Change of Operating Performance (Table 10)

- Acquirers with high pre-acquisition PPS also improve more in their operating performance.

## Conclusion

- High pay-for-performance sensitivity lead to value-enhancing mergers
- Banks with high PPS are less likely to acquire
- Market react positively to acquiring banks with high PPS
- Following acquisitions, acquirers with high pre-acquisition PPS improve more in operating performance