Pay-for-luck For Public Financial Corporation CEOs

The incentive compensation programs of general manager(CEO) is usually viewed through the lens of principal-agent model. General Manager usually has only a very small ownership interest on the firm they control. Since the principal and the agent have different utility functions, interest conflict exist among the principal-agent relationship. While the principal pursuit greater wealth, the agent want to maximize their compensation and leisure time. Executive payment is part of institutional arrangement to reduce interest conflicts. The contracting view of CEO pay assumes that pay is used by shareholders to solve an agency problem. Shareholders optimally design the pay package in order to increase the CEO’s incentive to maximize firm value. As researches have shown, CEO pay and firm performance are not perfectly related to each other. Unfortunately, pay for luck may exist. Shareholders will not reward CEOs for observable luck. By luck, here we mean changes in company performance that are beyond the CEO’s control. Tying pay to luck cannot provide better incentives.This paper starts by examining whether or not CEOs of publicly trade financial companies are in fact paid for luck using two measures of luck. With China’s economic reform and opening of financial market, rivalry among financial sector intensified. Because of the characteristic of financial industry, most of the relevant researches have excluded financial companies’data in sample selection process. This paper focuses on pay-for-luck in financial industry.After analyzing data of 43 main board financial companies from 2005 to 2012, we conclude that pay-for-luck do exist. In fact, we find that CEO pay is as sensitive to lucky performance as to general performance. To further examine compensation effectiveness, we test influence of corporate governance on pay-for-luck using several measure of governance: presence of large shareholders, CEO tenure, board size and CEO serving as chairman of the board. The findings suggest that at least some of the pay for luck in financial company is due to poor governance.