Abstract
This paper examines the impact of promotion-based tournament incentives on corporate acquisition performance. Measuring tournament incentives as the compensation ratio between the CEO and other senior executives, we show that acquirers with greater tournament incentives experience lower announcement returns. Further analysis shows that the negative effect is driven by the risk-seeking behavior of senior executives induced by tournament incentives. Our results are robust to alternative identification strategies. Our evidence highlights that senior executives also play an influential role in acquisition decisions in addition to the CEO.
Highlights
Corporate acquisitions are one of the largest forms of corporate investment
We rule out that our findings may be driven by an entrenchment hypothesis. This competing hypothesis arises as the pay gap between the chief executive officer (CEO) and other senior executives can be interpreted as CEO entrenchment (Bebchuk, Cremers, and Peyer 2011; Chen, Huang, and Wei 2013), and the prior literature has found that entrenched CEOs make worse acquisitions (Masulis, Wang, and Xie 2007; Harford, Humphery-Jenner, and Powell 2012)
We examine the effects of tournament incentives of senior executives, created by an observable pay differential between the CEO and other senior executives, on the performance of corporate acquisitions
Summary
Corporate acquisitions are one of the largest forms of corporate investment. As such, one would expect managers to exert a lot of effort into selecting acquisition targets that can create shareholder value. Our alternative risk-seeking hypothesis predicts that firms with greater tournament incentives are more likely to make more overly risky acquisitions as the senior executives in these firms are in theory more motivated to support the pursuit of extremely large and risky acquisitions to increase their own chances of securing a promotion We test these two competing hypotheses by empirically examining the relation between tournament incentives and acquisition performance using an extensive sample of 8,911 corporate acquisitions from 1994 to 2015. By using a large sample of corporate acquisitions, we are able to contribute new evidence on the effects of tournament incentives on corporate acquisition performance and provide an additional perspective in this debate
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