Whistle Blowing and CEO Compensation: The Qui Tam Statute

A purported dark side to powerful equity-based incentives is that they may induce a CEO to manipulate stock prices. With this in mind, recent theoretical models predict that firms will grant more equity-based compensation to their CEOs when the detection of any information manipulation is more likely. We provide confirming empirical evidence using three different tests. First, we use the qui tam statute as an experimental setting to test this prediction. This statute gives whistle blowers in the healthcare industry large financial incentives to reveal corporate fraud. Controlling for characteristics that might vary between the healthcare and other industries, we find that the proportion of equity-based compensation to total annual compensation is around 9% higher in the healthcare industry. Second, as third parties, such as the press, focus their investigative efforts towards large firms, we use an indicator variable to identify the largest firms in our sample and find that these firms are granted more equity-based compensation than others firms. Third, we use the passage of the Private Securities Litigation Reform Act (PSLRA) as an exogenous shock that increased the frequency of meritorious lawsuits. We find that equity-based compensation increased significantly after the passage of PSLRA. Using a difference-in-difference specification, we document that the effect of PSLRA on equity-based compensation is more pronounced for the healthcare industry and for the largest firms. The collective evidence appears consistent with theoretical models that predict that the detection likelihood of information manipulation affects the structure of CEO compensation. § Olin Business School, Washington University in St. Louis, Campus Box 1133, One Brookings Drive, St. Louis, MO 63130. Contact author: milbourn@wustl.edu. We appreciate helpful comments from Gerald Garvey, Eitan Goldman, Radha Gopalan, Todd Gormley, Chad Larson and Doug Skinner. We thank Lauren Barth for research assistance. Any remaining errors are our own.