IR papers: CEO pay ratio builds credibility
US investigators have uncovered a curious aspect of the newly mandated pay ratio disclosure: blaming others is a more effective strategy in terms of absolving the CEO from responsibility for poor company performance when a pay ratio disclosure is present than when it’s absent.
‘Conventional wisdom is that accepting blame for poor performance increases perception of a CEO's trustworthiness,’ says study co-author Nicole Cade, assistant professor of business administration at the University of Pittsburgh. ‘And you might think people would be more skeptical of chief executives once they saw these vast multiples. Instead, our experiment shows that [non-professional] investors react much less negatively to managers shifting blame to others within the company when the pay ratio is present.’
What is so influential about the pay ratio? The researchers propose that by exclusively locating the CEO in its numerator, the disclosure boosts perception of the CEO’s singular status, which in turn actually increases the persuasiveness of his/her excuses.
‘If you are going to blame others, doing so in a status-enhancing manner could offset some of the negative reaction of investors,’ adds study co-author Serena Loftus, assistant professor of accounting at Tulane University. ‘We chose to look at the pay ratio, but it’s likely there are other status enhancers for IROs to be aware of.’
IROs may, of course, wish to carefully weigh the pros and cons of a corporate landscape featuring even greater opportunity for the downhill rolling of executive detritus.
World o’ research
- Activist hedge funds are about 52 percent more likely to target firms with female CEOs than those led by males. Researchers posit that this is because activists believe (correctly) that females are more likely to be receptive to their intervention intentions. These encounters typically result in the female-led targets experiencing greater market and operational performance.
- The cleaner the air, the better the stock returns? Chinese researchers say firms based in cities with lower air pollution levels experience better returns than those located in high-pollution areas. The effect is strongest among firms most likely to be held by local investors.
- Investor reaction to unethical behavior is four times as negative for companies that claimed to be virtuous prior to their violation than for those that did not. US researchers say the results of their study reveal that top managers should exercise a measure of caution with their virtue rhetoric, especially if their language is more symbolic than substantive. The US research team concludes: ‘In short, if a firm has high perceived future value, top managers can essentially disregard the risk of communicating the firm’s ethical values. If perceived future value is low, top managers should only tout the firm’s ethics if they genuinely believe unethical behavior is unlikely to occur.’
- In a variety of experiments, a US research team has established that using red text fonts significantly impacts individuals’ risk preferences, expectations of future stock returns and trading decisions. In one experiment, a red color compared with a black color ‘suppressed’ risk-taking behavior by up to 30 percent. Additionally, the researchers estimate that investors who view potential financial losses in a red font may require about a 25 percent higher risk premium than when financial losses are represented in other colors. The effects are not present in color-blind individuals and are muted in China, where red represents prosperity. Other colors, including yellow and blue, do not generate the same effects.
- Including visuals in an earnings tweet significantly boosts investor attention, though not necessarily understanding of company performance. Researchers find evidence that managers use visuals opportunistically and that they are associated with lower earnings persistence and a post-earnings announcement return.
This article was originally published in the Summer 2021 issue of IR Magazine. Click here to access the magazine