FAYETTEVILLE, Ark. — A University of Arkansas finance professor studied 229 firms that laid off employees at least once between 1993 and 1999 and found that governing boards reward chief executive officers for the decision to let employees go. Specifically, for the year after a layoff occurred, CEOs of these firms received 22.8 percent more in total pay than CEOs of firms that did not have layoffs.

“We focused on layoffs because they are common operating decisions that affect shareholder wealth and thus CEO pay,” said Craig Rennie, assistant professor of finance in the Sam M. Walton College of Business. “Based on a comparison of CEO cash and stock-based pay for several years following layoffs, we believe CEOs receive pay increases as rewards for past decisions and motivation for value-enhancing decisions in the future.”

Finance researchers and industry experts know that stock-based compensation aligns managerial and shareholder interests. But, as Rennie emphasized, researchers are just beginning to explore how governing boards achieve the dual objectives of rewarding managers for past performance and motivating them to deliver value-enhancing decisions in the future. Rennie, Jeffrey Brookman and Saeyoung Chang, business professors at the University of Nevada, Las Vegas, examined CEO compensation to better understand how companies try to achieve this objective.

While significant, the overall percentage -- 22.8 percent more pay for CEOs of layoff firms -- is only part of the story and is tempered by an imbalance of its components. Total pay is the sum of cash pay -- salary plus bonuses -- and stock-based compensation, which includes restricted stock grants, stock option grants and money received from long-term incentive plans. The researchers’ findings confirmed earlier studies showing stock-based compensation aligns managerial and shareholder interests, which simply means that governing boards structure CEO compensation to ensure that managers’ goals for performance are the same as shareholders’.

For example, Rennie and his colleagues discovered that the year layoffs occur, CEOs of layoff firms received 19.6 percent more stock-based compensation than CEOs of non-layoff firms. This percentage increased significantly for years following layoffs. One year after layoffs, CEOs of firms that laid off employees received 42.6 percent more stock-based compensation than CEOs of non-layoff firms. Two years after layoffs, that percentage rose to only 44.9 but jumped to 77.4 percent after two years.

“Changes in CEO compensation after layoffs resulted in higher pay levels that persist,” Rennie said. “These rewards were not one-time or one-year events.”

Cash pay was an entirely different story. The researchers found that between 1993 and 1999, cash compensation, on average, was 6.5 percent lower for CEOs of layoff firms than CEOs of non-layoff firms the year before layoffs occurred. Salaries and bonuses for CEOs of layoff firms were 10.4 percent lower during layoff years. The year of layoffs, cash compensation was approximately the same for CEOs of layoff firms and CEOs of non-layoff firms.

“The fact that CEO cash pay is somewhat lower during the layoff year is consistent with political or union pressure on companies during periods of cutbacks,” Rennie said.

But while companies may have bowed to political or union pressure by slashing or not increasing CEO cash compensation during layoff years, governing boards did not ignore decisions by chief executive officers to cut back employees. Rennie emphasized that the period they studied was one of significant economic growth. During the 1990s, layoff announcements were generally considered a wealth-increasing measure that made firms more efficient and improved operating performance, a stark contrast to pre-1990 layoff announcements, which were negative news events that signaled temporary reductions in sales and generally poor financial performance. During the new era, governing boards were clearly satisfied with CEOs’ decisions to cut employees and increase efficiency.

“Our results were consistent with the view that layoffs create shareholder value,” Rennie said. “Layoffs are followed by an increase in operating income and a decrease in expenses. In addition to reducing direct labor costs and related overhead costs, layoffs also appear to increase future operating efficiency.”

Not surprisingly, increases in income and decreases in expenses pleased investors, Rennie found. They responded favorably to layoffs by generating abnormal stock returns immediately after the announcements. Rennie and his colleagues estimated that during this period of study, the typical layoff created a one-time labor-cost savings of at least $65 million.

The researchers’ findings will be published in The Financial Review, a leading finance journal. Rennie is the Clete and Tammy Brewer Professor of Business/Financial Markets in the Walton College.