CEO Compensation, Board Diversity, Innovation, and Firm Risk

Abstract

This thesis comprises three studies on internal corporate governance mechanisms. The first study examines whether CEOs with a large portion of inside debt pay reduce firm innovation, which is measured by the number of firm patents and citations. Inside debt compensation is an important component of the total executive pay package. The empirical results show that CEOs with high inside debt incentives decrease innovative output. The negative effect of inside debt compensation on innovative output is due mainly to pension benefits. CEOs with extensive inside debt holdings are associated with lower conversion of R&D spending into patents and a negative impact on innovation efficiency (research quotient). The second study explores the link between board diversity and CEO pay incentives. This research examines whether multi-dimensionally diverse boards adjust CEO pay incentives to encourage CEOs to follow less risky policies. Overall, the results show that heterogeneous boards reduce CEO equity incentives and increase the inside debt incentives to encourage CEOs to take less risk. The link between board diversity and CEO pay incentives is mainly attributable to the diversity of non-executive directors. More diverse compensation committees also tend to decrease CEO equity incentives and increase the inside debt incentives. The final study examines the impact of board faultlines and the interactive effect of multidimensional board diversity and faultlines on firm risk. This research shows that when the board faultline strength is higher (having greater cohesion between the subgroups in the board), the negative relationship between board diversity and stock return volatility becomes weaker. The diversity of both executive and non-executive directors has a positive association with firm risk when the board faultline strength increases.