The Disaggregation of, and Asymmetry in, CEO Pay-for-Luck

Abstract

Early work documents a sensitivity of CEO compensation contracts to economic factors beyond the control of the CEO, where CEO incentive payouts are increasing in performance attributable to good luck and decreasing in bad luck (referred to as “pay-for-luck”). Using established measures of luck, we confirm findings in more recent studies that finds no evidence of asymmetry in CEO pay-for-luck, where rewards for good luck are larger in magnitude than penalties for bad luck. When we employ an innovative method of disaggregating profitability drawn from the forecasting literature to disaggregate luck into orthogonal market and industry components, however, we find strong evidence of an asymmetry in CEO pay-for-luck, specifically related to luck around industry profitability. We investigate settings in which firms are more likely to try to retain incumbent CEOs and document pay-for-luck asymmetry only in profit-making firms. We also document pronounced pay-for-luck asymmetry in settings of (1) declining market and industry components of profitability, and growth rates, and (2) an increasing skill component of profitability, and growth in skill. Taken together, the cross-sectional findings support the prediction that evidence of CEO pay-for-luck asymmetry is motivated by CEO retention rather than CEO rent extraction.