The Effect of Supplier Industry Competition on Pay-for-Performance Incentive Intensity

Abstract

We examine how competition in supplier industries affects CEO incentive intensity in procuring firms. Using the Input-Output Accounts Data published by the Bureau of Economic Analysis, we compute a weighted supplier industry competition measure. We then predict and find that higher supplier competition is associated with stronger CEO pay-for-performance incentive intensity. This effect is incremental to the effect of competition in the firm’s own industry documented in prior research and is robust to using alternative measures of supplier competition as well as to exogenous shocks to competition. Importantly, we show that performance risk and product margin act as mediating variables in the relation between supplier competition and CEO incentive intensity providing support for the theory underpinning our finding. We document that CEO compensation contracts are used as a mechanism to exploit the market dynamics of upstream industries to a firm’s benefit. Our findings are economically important as external suppliers provide, on average, 45 percent of the value delivered by procuring firms to the market (BEA 2016).