Corporate Takeovers and CEO Compensation

Corporate takeovers are major investments that present managers with opportunities that can exacerbate the conflicts of interest between managers and shareholders, and thus present an ideal setting to explore the relationship between incentives and the efficiency of corporate investment decisions. This study examines CEO compensation and incentives around corporate takeovers, and thus sheds lights on the questions of when and why takeovers are initiated. We find that CEOs have clear financial incentives to undertake acquisitions—even though they are somewhat overpaid prior to an acquisition, their abnormal compensation increases following the acquisition. Further, growth through acquisition is explicitly rewarded. Bidding CEOs are paid more and their pay increases more for external growth than for internal growth. Substantial increases in option grants following a merger more than offset the negative effect of long-term underperformance on a bidding CEO’s pre-acquisition equity portfolio. However, all of these pay increases have a catch: they significantly increase the CEOs ’ pay and wealth sensitivity to firm performance, leaving them far more aligned with shareholder interests than they were before the acquisition