Financial Incentives and the Subordinates' Identification with the CEO

Abstract

Leadership research suggests that the CEO's subordinates identify with the CEO, and therefore desire to imitate his behavior. This paper studies how this desire impacts the CEO's and the subordinates' financial incentives and their effort decisions. The analysis is based on an agency model in which two agents, the CEO and a subordinate manager, are financially incentivized to perform a task for which the CEO's effort choice serves as an effort standard for the subordinate manager. The findings show that if the principal contracts with both agents, the subordinate manager's financial incentives decrease in his degree of identification with the CEO, as one might intuitively expect. However, the CEO's incentives can increase if he is sufficiently risk averse or the environmental risk is sufficiently high, which can result in an increase of the total incentives. If contracting with the subordinate manager is delegated to the CEO, the subordinate manager's incentives can increase in his degree of identification with the CEO as well. Accounting for the possibility that subordinates' effort decisions are influenced by financial incentives and by the effort choice of the CEO, the paper identifies conditions under which an increase in the degree of identification with the CEO results in lower effort levels.