An Examination of Firm-Manager Match Quality in the Executive Labor Market

Abstract

We use a three way mixed-effects model to quantify firm-manager match effects in executive compensation, and find that unobservable match heterogeneity explains a considerable proportion of the compensation variation. Firms compensate managers for productivity generated by the efficient match, so we propose a measure of firm-manager match quality based on the match effects in executive pay. We validate the proposed measure by showing that it captures systematic firm-manager complementarities and that it is positively and significantly associated with firm operating performance. We also find significant negative stock market reactions to the news of sudden deaths of CEOs with higher match quality, which helps address the concern that our match quality measure captures managerial rent extraction. Further, we show that match quality is an economically significant factor in CEO turnover decisions, an aspect of the executive labor market that features matching consideration prominently.