The effect of managerial ability on the association between ceo tenure and downward pay rigidity

Abstract

This paper explores the phenomenon of downward pay rigidity by employing a regimeswitching model that distinguishes between rigid and flexible regimes in U.S. companies during the 1993-2013 period. Downward pay rigidity refers to the asymmetric patterns that reflect positive pay-performance sensitivity when firms perform well, but less positive sensitivity when performance worsens. Depending on managerial power theory, we postulate that downward pay rigidity intensifies with CEO tenure. In addition, we investigate the effects of managerial ability on downward pay rigidity in relation to the effect of CEO tenure. The results suggest that CEO compensation is downwardly rigid for long-tenured CEOs. However, the results of the null hypothesis testing the incremental impact of CEO managerial ability on the association between CEO tenure and downward rigidity shows that talented CEOs with longer tenures are less likely to experience downward pay rigidity. The findings imply that long tenure of CEOs enables them to extract greater levels of rents. However, the incremental effect of CEO ability is consistent with the confidence hypothesis, suggesting that talented CEOs with long tenure are less likely to seek opportunities to extract rents than their less-talented counterparts. © 2020, Allied Business Academies.