CEO discretion, CEO tenure and executive pay-performance sensitivity: A dynamic model based on game theory

Abstract

Following the latest research trend which argues that the effects of CEO discretion on executive pay-performance sensitivity (EPPS) are some “contingent effects” instead of the “fixed effects”, the paper innovatively addresses the moderating role of CEO tenure in the relationship between CEO discretion and EPPS. For this purpose, based on the insights of game theory, the study creates a comprehensive theoretical algorithm model of EPPS with the introduction of two new critical variables, namely CEO discretion and CEO tenure into the classical principal-agent models of EPPS. By adopting the method of differential calculus, the model solution is calculated and further discussed. According to the model results, CEO tenure can moderate the relationship between CEO discretion and EPPS. To be specific, CEO discretion of fresh CEOs is positively related to EPPS; while for senior CEOs, CEO discretion is negatively related to EPPS. This finding is of great significance to reconcile the conflicting views on the relationship between CEO discretion and EPPS by proving fresh CEOs’ firm-serving motivations and senior CEOs’ self-serving motivations.