Abstract
Given the substantial stock and option portfolios held by most CEOs, much recent literature on CEO incentives regards cash-based bonus plans as largely irrelevant. This begs the question of why nearly all CEO compensation plans include such bonuses. We re-examine the financial incentives provided by bonuses and their role in executive compensation packages. Using detailed data on bonus-plan performance measures, we document that the pay-performance sensitivity of CEO cash compensation is much greater than prior estimates and that cash-based pay provides a substantial portion of many CEOs’ total financial incentives early in their tenure. However, we find little evidence that boards adjust bonus plans over time in response to CEO-specific characteristics, such as the evolution of CEO equity holdings or liquidity needs. This “stickiness” results in growing disparity between the magnitudes of cash- and equity portfolio-based incentives over a typical CEO’s tenure. At the same time, we find evidence that bonus plans appear to consider liquidity and incentive issues for lower-level executives, leading us to conclude that cash-based plans are designed mainly for the overall management team, as well as perhaps new CEOs.
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