Kelly Shue

Executive Networks and Firm Policies: Evidence from the Random Assignment of MBA Peers

Using the historical random assignment of MBA students to sections at Harvard Business School (HBS), I explore how executive peer networks can affect managerial decision making. Within an HBS class, firm outcomes are significantly more similar among graduates from the same section than among graduates from different sections, with the strongest effects in executive compensation and acquisitions strategy. I demonstrate the role of ongoing social interactions by showing that peer effects are more than twice as strong in the year following staggered alumni reunions. Supplementary tests suggest that peer influence can operate in ways that do not contribute to firm productivity. The Author 2013. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oup.com., Oxford University Press.

How Do Quasi-Random Option Grants Affect CEO Risk-Taking?

The financial crisis renewed interest in the relation between compensation incentives and risk taking. We examine whether paying top executives with options induces them to take more risk. To identify the causal effect of options, we exploit two distinct sources of variation in option compensation that arise from institutional features of multi-year grant cycles. We find that a 10 percent increase in the value of new options granted leads to a 6 percent increase in firm equity volatility. This increase in risk is primarily driven by an increase in leverage. We also find that an increase in stock options leads to lower dividend growth with mixed effects on investment and firm profitability. JEL Classification: M52, J33, G32, G34We examine how an increase in stock option grants affects CEO risk-taking. The overall net effect of option grants is theoretically ambiguous for risk-averse CEOs. To overcome the endogeneity of option grants, we exploit institutional features of multi-year compensation plans, which generate two distinct types of variation in the timing of when large increases in new at-the-money options are granted. We find that, given average grant levels during our sample period, a 10 percent increase in new options granted leads to a 2.8–4.2 percent increase in equity volatility. This increase in risk is driven largely by increased leverage.

Growth Through Rigidity: An Explanation for the Rise in CEO Pay

The dramatic rise in CEO compensation during the 1990s and early 2000s is a longstanding puzzle. In this paper, we show that much of the rise can be explained by a tendency of firms to grant the same number of options each year. Number-rigidity implies that the grant-date value of option awards will grow with firm equity returns, which were very high on average during the tech boom. Further, other forms of CEO compensation did not adjust to offset the dramatic growth in the value of option pay. Number-rigidity in options can also explain the increased dispersion in pay, the difference in growth between the US and other countries, and the increased correlation between pay and firm-specific equity returns. We present evidence that number-rigidity arose from a lack of sophistication about option valuation that is akin to money illusion. We show that regulatory changes requiring transparent expensing of the grant-date value of options led to a decline in number-rigidity and helps explain why executive pay increased less with equity returns during the housing boom in the mid-2000s.

Promotions and the Peter Principle

The best worker is not always the best candidate for manager. In these cases, do firms promote the best potential manager or the best worker in her current job? Using microdata on the performance of sales workers at 214 firms, we find evidence consistent with the “Peter Principle,” which predicts that firms prioritize current job performance in promotion decisions at the expense of other observable characteristics that better predict managerial performance. We estimate that the costs of promoting workers with lower managerial potential are high, suggesting either that firms are making inefficient promotion decisions or that the benefits of promotion-based incentives are great enough to justify the costs of managerial mismatch.