Are Incentive Contracts Rigged by Powerful CEOs?

Are Incentive Contracts Rigged by Powerful CEOs?

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Article ID: iaor201112093
Volume: 66
Issue: 5
Start Page Number: 1779
End Page Number: 1821
Publication Date: Oct 2011
Journal: The Journal of Finance
Authors: , ,
Keywords: contracts
Abstract:

We argue that some powerful CEOs induce boards to shift the weight on performance measures toward the better performing measures, thereby rigging incentive pay. A simple model formalizes this intuition and gives an explicit structural form on the rigged incentive portion of CEO wage function. Using U.S. data, we find support for the model’s predictions: rigging accounts for at least 10% of the compensation to performance sensitivity and it increases with CEO human capital and firm volatility. Moreover, a firm with rigged incentive pay that is one standard deviation above the mean faces a subsequent decrease of 4.8% in firm value and 7.5% in operating return on assets.

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