Mergers Benefit CEOs Disproportionately

Wednesday, August 15, 2007

Prof. Jarrad Harford and Prof. Kai Li, University of Washington Business School (JH); Sauder School of Business, University of British Colu, http://

Abstracted from: Decoupling CEO Wealth And Firm Performance: The Case of Acquiring CEOs

Journal of Finance - Vol. 62, No. 2, Pgs. 917-950

Mergers trigger new compensation packages.
CEOs often have to decide between corporate growth through capital investments or growth through acquisition. In theory, linking the chief executive officer's compensation to the company's stock performance through options and grants should align the CEO's interests with those of the stockholders. Yet the CEO also benefits if the company makes a major capital investment that increases the corporate value. Finance professors Jarrad Harford and Kai Li questioned which pathway is more advantageous for the CEO. Given the choice between capital investment or acquisition, the CEO benefits dramatically more from mergers than capital expenditures, the authors discovered. A capital expenditure ­even a major one ­rarely triggers an enhanced CEO compensation package, but mergers almost always do. The CEO of the acquirer usually receives so much additional post-merger compensation that any personal losses from the falling stock value of a poorly performing merger are handily offset.

Even poor mergers make CEOs richer.
Personal wealth and compensation increased for 78% of the CEOs in value-destroying mergers, the authors reveal. While the average acquiring company under-performs the market by about 5%, their CEOs realize a 121% increase in wealth as a result of new grants and options. CEOs of successful mergers benefit even more dramatically. CEOs presiding over an over-performing merger increase their wealth by 194%; at the 90th percentile, this is an increase of 308%. Even the CEOs of under-performing mergers make money: they increase their wealth by an average of 70%. Only the worst-performing mergers result in losses for the CEO. For the lowest 10% of under-performing mergers, the CEOs lose money but only 15% of their personal wealth. By the 25th percentile of under-performing mergers, CEOs have increased their wealth by 5%. From the CEO's point of view, clearly the odds strongly favor undertaking even a questionable merger.

Compensation packages sever the linkage.
The restructured, enhanced compensation packages that boards award post-merger effectively break the link between corporate performance and CEO pay. The additional compensation triggered by the merger far exceeds what is triggered by other growth-generating activities such as capital expenditures. CEOs enjoy relatively slight increases in wealth after major expenditures, while those guiding the biggest expenditures actually have stagnant compensation packages. By contrast, even a bad merger so quickly increases the CEO's personal wealth that it encourages the executive to opt for a bad merger over a good capital expenditure. For the authors, the unanswered question is why boards structure post-merger compensation so that it unlinks pay from performance, leaving CEOs with little incentive to grow the company organically.

Abstracted from Journal of Finance, published by American Finance Association, Haas School of Business, University of California, Berkeley, CA 94729.

Return to Library of Business Information