The influence of security analysts on CEO pay cuts

This study investigates the role of external monitors, in the form of analyst recommendations, on CEO pay cuts. We use the theories of signaling and optimism to arrive at propositions that predict the relationship between analyst recommendations as external monitors, and CEO pay cuts. CEO pay cuts - which constitute a strong incentive for CEO behavior - have received only limited attention in extant research. Analysis of data for US public firms from 1998 to 2013 suggest that firms with strong external monitoring mechanisms, such as public analyst recommendations, are more likely to implement pay cuts. Our findings reveal that analyst recommendations serve as important and objective external signals and a monitoring mechanism for determining CEO pay cuts. Specifically, low-performing firms and firms with high CEO pay before analyst recommendations are more likely to integrate the analyst downgrades in their decision process regarding CEO compensation. From our analysis, practitioners could learn that - even though they might find it difficult to implement CEO pay cuts - such pay cuts are not only effective but also could be implemented based on external signals from analysts. A takeaway for external analysts is the powerful effect that their negative signals have on CEO pay cuts, thus questioning the optimism bias that is so prevalent in the industry. In order to serve as truly 'objective' external monitors, analysts should use ratings judiciously as signaling mechanisms. © 2016 Macmillan Publishers Ltd.