CEO Personality and Compensation

Steve Kaplan, University of Chicago Booth

Anastasia Zakolyukina, University of Chicago Booth 

While the standard agency theory predicts a trade-off between risk and incentive pay, there is not much direct evidence on how CEOs risk-aversion affects their compensation (e.g., Prendergast, 1999, Graham et al., 2013). At the same time, Graham et al. (2012) find that manager fixed effects explain over half of the variation in executive compensation. These fixed effects can capture unobservable CEOs characteristics, which may include risk aversion, time preference, and skill. Graham et al. (2013) measure the CEOs risk-aversion and time preference using a survey. They collect responses from 1,017 CEOs of U.S. firms with 11.5% of these firms being public. The authors find that more risk-averse CEOs are significantly more likely to be compensated by salary than by performance-based compensation with more impatient CEOs being more likely to be compensated more in salary. While the survey approach allows to measure specific CEOs characteristics, it is not without limitations. Surveys might measure beliefs not real actions and limit the sample to CEOs who decide to participate in the survey. In this project, we can overcome some of the limitations of the survey approach and measure CEOs risk-aversion, time preference, and skill indirectly using the narratives from conference calls for a broader cross-section of CEOs. We plan to utilize our measures of Big Five personality traits from “CEO Personality and Firm Policies” project. These Big Five traits include two polar dimensions: Extraversion (versus Introversion), Emotional Stability (versus Neuroticism), Agreeableness, Conscientiousness, and Openness to Experience. The psychology literature suggests  that these Big Five traits can be mapped to the traits commonly studied by economists such as risk-aversion, time preference, and skill.