Enhancing Managerial Incentives and Value Creation: Evidence from Corporate Shifts

Article Analysis

The article “Enhancing Managerial Incentives and Value Creation: Evidence from Corporate Shifts” by Unyong Pyo provides detailed overview and analysis of changes in corporate spinoffs in CEO compensation. In particular, the author examines the effects of spinoffs on managerial incentive compensation. The key question is whether operating performance and value chain improvements can be explained by changes in managerial compensation. Practical side of the research is analysis of 124 non-taxable spinoffs, and the period covered is 1990-1997. Pyo’s thesis is that spinoffs are not directly related to operating performance improvements, whereas managerial incentives are affected by changes in operating performance. Nevertheless, changes in business aren’t consistent with changes in spinoff. Increased business focus doesn’t improve pay-performance as well.

Pyo writes that “a corporate spinoff divides a company into two or more independent firms and offers a firm an opportunity to improve managerial incentives with fresh compensation packages directly tied to its own stock price”. (Pyo, p.343) Thus, Pyo is willing to show that market reaction on corporate spinoffs is positive on average.  Moreover, spinoffs may be reduced in case diversity costs are removed and negative financial synergies are eliminated. However, managerial incentives don’t affect both of them. Managerial compensation is argued to be positive for reducing agency conflicts, but no empirical evidence shows managerial incentive compensation is affected by corporate spinoffs. Little evidence shows that operating performance improvements and enhanced managerial incentives are attributed to corporate spinoffs.

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Pyo writes that a sample of 124 spinoffs was examined with the purpose to analyze benefits of corporate spinoffs and to examine the effect of managerial incentive on compensation. Pyo argues that corporations are encouraged by spinoffs to implement new original compensation packages. However, it is necessary to admit that fresh compensation packages are possible only if stock price of the corporation is not related to managerial performance within multi-national corporation. Corporate spinoffs are effective for changes implementation and managerial incentives improvements. By examining compensation sensitivity and operational performance, Pyo is willing to identify whether managerial incentive is related to spinoffs. The results show that changes in managerial incentives are able to affect value enhancements if they follow corporate spinoffs. However, only spinoff subsidiaries may benefit from such changes, whereas post-parents may not.

Pyo stresses that “results supporting the managerial incentive hypothesis are that spinoff subsidiaries increase pay-performance sensitivity in line with size effects” meaning that “pay-performance sensitivity for subsidiaries does not decrease when the CEO of pre-spinoff parent firms jumps to a spinoff subsidiary”. (Pyo, 351) Subsequently, it means that changes in managerial incentives are the result of focus-increasing spinoff, not non-focus-increasing one. Pyo claims that operating performance depends on managerial incentives and, of course, on managerial compensation. With payment increase operating performance is very likely to increase as well because no one is willing to work more and to be paid less. Monetary compensation plays important role in job satisfaction and operational performance. However, business focus doesn’t improve operating performance and managerial compensation.

Pyo admits the minimal relations between operating performance and business focus, whereas research proves that the relations between operating performance and managerial incentives are significant and close as they are mutually dependent. The key strength of the research is that Pyo brings new investigation and fresh practical results for investigating gains of corporate spinoffs. Pyo concludes that “the pay-performance relations improve following spinoff distributions in three aspects”. (Pyo, p.353) Such conclusion is apparent because research shows that pay-performance sensitivity increases for spinoff subsidiaries, not for pre-parents. Moreover, pay-performance sensitivity doesn’t decrease for spinoff subsidiaries when “when a pre-parent's CEO becomes a spinoff subsidiary’s CEO adjusting for size effects”. (Pyo, p.348)  These explanations lead to conclusion that higher incentives should be offered to spinoff subsidiaries.

Corporate spinoffs are argued to be acting as incentives for divisional managers because productivity of any division in subsidiary is related to the stock value of diversified parent firm. Therefore, Pyo concludes that managerial incentives can be improved by spinoff subsidiary by increasing its pay-performance sensitivity. Moreover, operating performance enhancement is the result of focus increases and managerial incentives improvements. Of course, managerial incentives are not solely responsible for operating performance. Pyo sums up that “increased business focus following spinoffs creates value because the spinoffs allow managers to focus attention on the core business they are best suited to manage”. (Pyo, p.345) Changes in operating performance are also related to pay-performance sensitivity meaning that increase in pay-performance sensitivity results in improved operating performance, whereas decrease in pay-performance sensitivity won’t result in improved performance and productivity. Corporate spinoffs are highly motivated by changes in managerial incentives, and in some cases spinoffs appear to be effective way to re-think and re-write managerial performance contracts. Overall firm performance and efficiency will be improved as well.

References

Pyo, Unyong. (2007). Enhancing Managerial Incentives and Value Creation: Evidence from Corporate Shifts. Journal of Economics and Finance, 31, 3, pp.341-358.

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