Government spending and CEO equity incentives: Evidence from changes in U.S. Senate committee chairs

Abstract

This study examines the impact of government spending on CEO equity incentives. Using changes in U.S. Senate committee chairs as a source of exogenous variation in state-level federal government spending, we find that firms headquartered in a state whose senator becomes a committee chair significantly reduce the convexity of their CEOs’ option-based pay, as captured by portfolio vega. This effect is more pronounced for firms with greater reliance on the government, more geographically concentrated operations, and in states with tighter local labor markets. We further find that in response to a government spending shock, firms actively adjust CEOs’ risk-taking incentives by decreasing CEO vega from annual option grants and decreasing both the number and value of CEOs’ option grants. Additionally, we document a shift in the compensation structure towards increased fixed salary and higher bonus compensation, accompanied by a shorter pay duration. Finally, we show that following the increase in government spending, firms receive more procurement contracts, experience reduced performance volatility, and those providing CEOs with less convex payoffs show lower R&D investment. Overall, our findings suggest that the positive shock to government spending due to a new committee chair reduces a firm’s desired level of risk-taking, which discourages offering risk-taking equity incentives to the CEO.