Abstract
This paper examines unintended consequences of executive compensation regulation using Israel's 2016 law that imposed binding caps on financial firms' executive pay. Using a dynamic difference-in-differences design, I analyze how these caps affected compensation in unrestricted firms to test whether executive pay reflects optimal contracting or rent extraction. The findings reveal that executives at unrestricted firms whose compensation previously exceeded the cap experienced significant pay reductions following implementation. I document two mechanisms driving these effects: executive mobility between restricted and unrestricted sectors, and direct anchoring — whereby the regulatory threshold became a salient reference point influencing compensation decisions at firms entirely outside the regulatory scope. The absence of significant transmission through ownership and director network channels supports the direct anchoring interpretation. These findings provide evidence consistent with rent extraction theory, showing that targeted sector-specific regulations can be associated with significant unintended consequences extending well beyond their explicit scope.
Keywords: Executive compensation, Rent extraction, Financial regulation, Corporate governance
JEL Classification: G34, G38, M12, M52, H11