Boards sometimes cut a CEO’s pay following poor performance. This study examines whether such CEO paycuts really work.

We identify 1,496 instances of large CEO paycuts during the period 1994-2013. We then create a propensity-score-matched control group of firms that did not cut their CEOs’ pay and employ a difference-in-differences approach to examine the consequences of paycuts.

Our results show that, following a paycut, CEOs are likely to engage in earnings management in an attempt to accelerate improvement in the reported performance and to achieve a speedier restoration of their pay to pre-cut levels.

Further, we find that improvement in long-term performance after a paycut occurs only for those firms with lower levels of earnings management after the paycut.

Finally, we show that paycuts are more likely to lead to unintended value-destroying consequences in the absence of high institutional ownership or when the CEO is sufficiently entrenched, thereby impairing the effectiveness of internal monitoring by boards.

By: Gerald J. Lobo (University of Houston – C.T. Bauer College of Business), Hariom Manchiraju (Indian School of Business (ISB), Hyderabad), and Swaminathan Sridharan (Northwestern University – Kellogg School of Management)

Read the forthcoming Journal of Accounting and Public Policy article here