Promotion Incentives and Corporate Performance: Is There a Bright Side to “Overpaying” the CEO?

Abstract

Earlier studies have shown that stronger equity‐based incentives for CEOs are generally associated with better corporate performance and higher values. In this article, the authors report the findings of their recent study of the effects of promotion‐based “tournament” incentives for non‐CEO executives (or “VPs”) on corporate performance for a large sample of companies during the 12‐year period from 1993‐2004.The study's main finding is that such tournament incentives, as measured by the pay differential between the CEO and VPs, were associated with better corporate operating performance and higher corporate stock returns. Moreover, tournament incentives, as one would expect, appeared to be more effective when CEOs were nearing retirement—but less effective when the firm had a new CEO (and even weaker when the new CEO was an outsider).