Institutional Trading, Information and Executive Compensation

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Abstract
This paper develops new theory and evidence regarding the role of institutional trading in influencing executive pay-for-performance (PPS) sensitivity. Given managerial ability to "skim" proceeds, and skimming to be less costly for shareholders given profit sharing between shareholders and managers, our model shows that more informative stock prices leads to less PPS contracting. Utilizing a sample of 72,000 executive-years, we find that institutional trading is negatively related to board decisions on PPS, and that the pattern of the effect is consistent with informed trading. Our results are robust to alternate specifications of our institutional trading and PPS measures. Institutional trading is negatively related to total compensation, indicating that institutional trading is not a proxy for lack of monitoring. Overall, our model and evidence imply that institutional trading acts as a substitute for pay for performance in executive compensation via an interaction with the information content of stock prices.

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