Journal of Tourism Research & Hospitality ISSN: 2324-8807

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Case Report, J Tourism Res Hospitality Vol: 7 Issue: 1

Stock Liquidity and CEO Compensation in the US Hospitality Industry

Li Ding*

School of Hospitality and Tourism Management, College of Human Sciences, Oklahoma State University, USA

*Corresponding Author : Li Ding
School of Hospitality and Tourism Management, College of Human Sciences, Oklahoma State University, USA
E-mail: [email protected]

Received: December 04, 2017 Accepted: January 05, 2018 Published: January 11, 2018

Citation: Ding L (2018) Stock Liquidity and CEO Compensation in the US Hospitality Industry. J Tourism Res Hospitality 7:1. doi: 10.4172/2324-8807.1000182


This paper examines the effect of stock liquidity on CEO compensation in the US hospitality industry. By using a panel data sample of 50 US publicly traded hospitality companies from 1993 to 2014, the study finds that US hospitality companies with a high stock liquidity tend to have a higher proportion of equity-based CEO compensation schemes and a lower proportion of cash-based compensation. This study provides the board of directors with useful insights to alleviate agency problem and improve corporate governance efficiency.

Keywords: Stock liquidity; Stock turnover; CEO compensation; Hospitality; Agency theory; Corporate governance; Equity-based compensation


The average compensation among CEOs at the largest 350 publicly traded US companies was as high as $16.3 million in 2014, and the top CEOs earned over 300 times more than typical workers [1]. Moreover, their pay growth was apparently faster than the companies’ stock gains growth [1]. Stakeholders have been concerned about CEO compensation and the compensation structure for decades, especially when companies with poor performance still overpay their CEOs. Such examples exist in the hospitality industry. In 2002, the CEO of Denny’s Restaurant was paid a $1.3 million bonus even though the company lost $88.5 million [2]. The problem is mainly attributed to the agency problem between the CEO and shareholders [3]. To align CEOs’ self-interests and shareholders’ interests and reduce the agency costs, the equity-based compensation has been increasingly used to reward CEOs in recent decades [4]. Ideally, the CEO compensation is designed to reflect the company’s short-term and long-term performance. For example, on the 2015 DEF 14A proxy statement, YUM stated its executives’ compensation philosophy as rewarding performance and emphasizing long-term value creation. However, previous evidence showed that only a small portion of the CEO compensation variations had been explained by companies’ financial performance [5]. The intuition behind this fact is that the hospitality industry demonstrates extreme sensitivity toward the prevailing macroeconomic condition [6]. During a weak economy, people spend less on hospitality-related products and services, such as traveling, staying in hotels and dining out in restaurants. This slackened demand may directly cause hospitality companies’ poor performance, which is not attributable to the CEO’s guidance [6]. Therefore, hospitality companies tend to reprice their stock options during periods of market slumps to realign CEO incentives to the company’s value [6]. It makes CEO compensation in the hospitality industry more ambiguously explained by a company’s performance.

In recent years, CEO compensation has tended to rely more on the performance of the company’s stock, while the importance of cash-based compensation is diminishing [7]. This trend generates the need to explore how company performance in the stock market is associated with CEO compensation. Stock price and trading volume are two basic elements and are tied together in financial markets [8,9]. The relationship between the stock price and CEO compensation has received considerable attention [10-12]. However, the relation between trading volume and CEO compensation has not been discussed as much as the stock price. Given the characteristics of tightness, depth, resiliency, and immediacy [13], an important role in the stock market is played by stock liquidity, “the ability to trade the stock rapidly with little price impacts” [14]. It can be measured by the proxy of stock turnover ratio, which discusses the stock trading volume [15,16]. Following the agency theory, optimal contracting theory and signalling theory, empirical evidence has shown that high stock liquidity is associated with higher equity-based CEO compensation [17,18]. However, the studies on stock liquidity influencing CEO compensation in the hospitality industry are limited. This study aims to investigate a relationship in the hospitality sample. The result may point out that stock liquidity is an efficient indicator of CEO compensation in the hospitality industry and help the board of directors to construct more efficient corporate governance policies.

Literature Review

Agency theory and CEO compensation

Agency theory addresses the “causes and consequences of goal divergence between the two parties” [19]. In order to manage a company successfully and efficiently, shareholders (principle) have to transfer a part of the decision-making authority to the managers (agent) with contracts [20]. Working as the agent, the CEO may have goal conflicts and different contractual arrangements with the shareholders [21]. Typically, they are more likely to maximize their self-wealth rather than the shareholders’ wealth [19]. Along with such goal conflicts and misaligned interests between CEO and shareholders, the principal always encounters difficulties to monitor and verify the agent’s behaviours and outcomes [22]. It may increase the agency costs [20]. Positive agency theory suggests that agency costs can be reduced by establishing an outcome-based contract (e.g., stock options) because it can alleviate agent opportunism by aligning the preferences of both the CEO and shareholders [22]. The principalagent theory argues that the efficiencies of outcome-based contracts and behaviour-based contracts rely on other factors such as outcome uncertainty, risk aversion, and information systems as well [22].

The agency costs motivate the shareholders to use compensation rewards based on the performance [23]. CEO compensation refers to “all company benefits paid to executives, including basic salary, short-term and long-term incentives, bonus, share options, and other forms of compensation” [20]. It is an efficient approach to reduce agency costs. It is determined by the CEOs’ labour market supply and demand, and the CEOs’ managing efforts toward the companies [24]. Cash-based and equity-based compensation are two commonly used CEO compensation formats [25]. The cash-based compensation consists of the CEO salary and bonus. Determined by the CEOs’ labour market supply and demand, the CEO salary is behaviour-based compensation, and may not vary with the goal performance. It serves as a signal of the CEOs’ observed past performance [26]. A bonus is a short-term outcome-based compensation [27]. It signals the CEOs’ observed current performance after the fixed salary has been settled [26]. The cash-based compensation structure may minimize CEOs’ adverse selection and moral hazard [26]. The equity-based compensation mainly includes stock options and restricted stocks [28]. Stock options are “contracts which give the recipient the right to buy a share of stock at a pre-specified exercise price for a pre-specified term” [29]. The CEO enjoys a gain if the company’s stock price is higher than the exercise price when the CEO exercised the granted stock options. In order to diversify the risk, CEOs may sell restricted stocks once they can be vested [30]. The equity-based compensation structure can align the CEO’s self-wealth with the company’s longterm performance and drive the CEO’s preferences and efforts to benefit the shareholders [22,28,31]. Equity-based compensation has been taken up a significant portion of total CEOs compensation and growing fast [32]. However, the growing equity-based CEOs compensation also causes several negative concerns. Significantly rewarded by equity-based compensation, the CEOs have attempt to influence companies’ earnings management and stock price [33]. Because of their personal wealth closely tied with companies’ equity, they may be not willing to suffer the risks from the investment projects [34]. A risk-averse CEO preferred cash-based compensation to the equity-based compensation [35].

Stock liquidity and CEO compensation

Because it is multi-dimensional, stock liquidity is measured in a variety of ways in the literature, such as through stock turnover [36], bid-ask spread [37], and the Amihud illiquidity ratio [38]. Stock turnover measures the standardized stock trading volume and takes the number of shares outstanding into account [15,39-41]. Such a trading frequency-based measure is used as the proxy of stock liquidity in the literature [15,39-41].

The influence of stock liquidity on CEO compensation is documented by the literature. For example, Jayaraman and Milbourn (2012) investigated the relationship between stock liquidity and CEO compensation and found that higher stock liquidity led to higher equity-based CEO compensation [17]. Lin et al. also consistently found that the high stock liquidity drove up equity-based compensation [18]. The rationale is closely associated with the agency, optimal contracting and signalling theories. It is unrealistic that stock prices perfectly reflect the information due to the information acquisition costs [42]. Therefore, informed and uninformed trading coexist in the market. When the uninformed trading introduces the randomness to the stock prices, the stocks become more liquid [43]. As the liquidity increases, stock trading costs decrease, which makes less costly for the executives to sell their equity holdings [44]. Along with their frequent trading, the company’s stock prices impound more information about the executives’ actions [45,46]. Informed trading increases as the information acquisition costs decrease [42,47]. At equilibrium, informed trading increases to dominate uninformed trading [43]. With the valuation of greater stock liquidity and impounded information about executives’ actions, CEOs tend to hold more equity-based compensation than cash-based compensation [46]. Moreover, riskaverse CEOs prefer holding equity-based compensation to cash-based compensation in companies with high stock liquidity [17]. Therefore, this study establishes the hypotheses as below.

Hypothesis 1. The stock liquidity positively associates with equitybased CEOs’ compensation proportion in hospitality sample.

Hypothesis 2. The stock liquidity negatively associates with cashbased CEOs’ compensation proportion in hospitality sample.


Sample and data collection

This study aims to examine the impact of stock liquidity on CEO compensation in the hospitality industry. CEO compensation data were extracted from the ExecuComp database. The data were merged with financial data from COMPUSTAT Fundamentals Annual databases under the hospitality settings (NAICS 2-digit Sector Code 72 accommodation and food services). After removing the outliers and winsorizing at 1% and 99% on ratio variables [48], the sample consisted of 571 company-year observations across 50 US publicly traded hospitality companies for the period of 1993-2014.

Variables and measures

This study employs Model (1)-(2) to reach our research purposes. The dependent variables are cash-based compensation proportion and equity-based compensation proportion. While the cash-based compensation consists of a CEO salary and bonus, the equity-based compensation includes a CEO restricted stocks and stock options [49]. The cash-based compensation proportion divides cash-based compensation by the total compensation. Similarly, equity-based compensation proportion divides equity-based compensation by total compensation. This study uses a lagged independent variable, the stock turnover (stockturnovert-1) to measure the stock liquidity and account for the effect on compensation over time and to avoid potential problems of simultaneity. It is calculated by using common shares traded annually, divided by the average number of annual common shares outstanding [50]. Control variables include firm size, debt leverage, market-to-book ratio, profitability, Tobin’s Q, and the CEO’s characteristic variables (i.e., age, gender, and tenure) at time t-1. The logarithms of net sales at the fiscal year end are used to measure firm size [20]. The leverage is computed using total debt divided by the sum of total debt and the market value of equity [49]. The market-to-book ratio is computed using the market capitalization divided by the book value of equity [49]. The profitability is measured by the operating income before depreciation divided by the total assets [51]. Tobin’s Q is calculated from Equation (1) [52]. The error terms account for other unexplained variances. The proposed models are presented below.



Descriptive statistics

Table 1 presents a descriptive statistics summary of the dependent and independent variables in the sample. We find that most CEOs are male and the average age is around 56 years old. On average, they had worked as the CEO for 6.68 years in the company. The cash-based CEO compensation mean is 1.34 million (S.D.=1.19) while the equitybased compensation mean is 4.70 (S.D.=11.64). The cash-based compensation has the higher percentage (Mean=0.54, S.D.=0.35) than the equity-based compensation percentage (Mean=0.41, S.D.=0.37). The average stock turnover ratio is 2.45 (S.D.=1.95).

  Mean SD
Cash-based compensation (Millions) 1.34 1.19
Equity-based compensation (Millions) 4.70 11.64
Cash-based compensation percentage 0.54 0.35
Equity-based compensation percentage 0.41 0.37
Stock turnover 2.45 1.95
Firm size 7.27 1.22
Leverage 0.24 0.20
Market-to-book ratio 4.02 6.10
Profitability 0.17 0.07
Tobin's Q 1.96 1.07
CEO age 55.84 7.73
CEO gender 0.97 0.17
CEO tenure 6.68 6.62

Table 1: Descriptive Statistics Summary.

Fixed effects model estimations

The fixed effects model and random effects model are commonly used in panel data analysis. The fixed effects model controls the effects from time-invariant characteristics, while the random effects model copes with the degree of significance loss in fixed effects model [53]. The Hausman test is employed to specify the appropriate model [54]. The null hypothesis of Hausman test indicates the existence of random effects. The Model (1) rejects the null hypothesis (P value=0.0021) and the Model (2) rejects the null hypothesis (P value=0.0000) at the significant level of 0.05. It means that using fixed effects estimation method is appropriate to both models.

Table 2 presents the regression results. We included two models that respectively employed cash-based CEO compensation percentage and equity-based CEO compensation percentage as dependent variables. We used White robust estimator to remedy the possible heteroscedasticity issue [55]. The results show that Model (1) and Model (2) are significant (p<0.05). The stock turnover ratio significantly and negatively relates to the cash-based CEO compensation percentage (Coefficient=-0.024, p=0.027), while significantly and positively relating to the equity-based CEO compensation percentage (Coefficient=0.032, p=0.019). Hypotheses 1 and 2 are supported by the results. The control variables, such as firm size, leverage, profitability, and Tobin’s Q do not present a significant relationship with cash-based CEO compensation percentage or equity-based CEO compensation percentage. The male-dominated CEOs tend to hold more cash-based compensation in our hospitality sample.

Dependent variable Cash-based CEO compensation percentage t Equity-based CEO compensation percentage t
  Coefficient S.E. P-value Coefficient S.E. P-value
Stock turnover t-1 -0.024 0.010 0.027* 0.032 0.013 0.019*
Firm size at t-1 -0.212 0.058 0.001* 0.211 0.060 0.001*
Leverage t-1 -0.017 0.155 0.916 0.070 0.186 0.709
Market-to-book ratio t-1 -0.002 0.005 0.676 -0.010 0.003 0.000*
Profitability t-1 -0.687 0.413 0.104 0.521 0.503 0.306
Tobin's q t-1 -0.007 0.041 0.865 0.032 0.044 0.470
Ln[CEO age t-1] -0.369 0.264 0.168 0.451 0.304 0.146
CEO gender t 0.337 0.052 0.000* -0.399 0.090 0.000*
Ln[CEO tenure t-1] -0.018 0.029 0.545 0.021 0.030 0.490
Constant 3.392 1.063 0.003 -2.754 1.171 0.023
F statistics 20.13* 13.02*        
Overall R-Square 0.2261 0.2461        

Table 2: Fixed-effect hypothesis tests.

Conclusions and Discussions

The estimation results in the hospitality sample show that an increase in stock liquidity is likely to decrease cash-based compensation proportion and increase equity-based compensation proportion in the CEO compensation package in the subsequent period. The results confirmed the findings of other related studies [17,18]. The increased stock liquidity may reduce trading costs and make the stock price impound more information about the company’s executives’ actions [17]. Risk-averse CEOs have a strong preference for stock liquidity since greater stock liquidity tends to reduce the bidask spread and the costs of selling their positions. Consequently, the CEOs would like to hold more equity-based compensation, compared to the cash-based compensation during the compensation contracting process [17]. The results suggest that the hospitality companies with higher stock liquidity use more equity-based compensation as part of total compensation to reward their CEOs. This paper empirically contributes to corporate governance practices in the hospitality industry. By exploring the relationship between stock liquidity and hospitality firms’ CEO compensation, it offers the board of directors an insight of CEO compensation structure determinants and points out the equity-based compensation as an important component of the CEO incentive package.


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