Incentive Compensation Schemes Research Articles

CEO Pay-performance Sensitivities in the ESG Managed Firms

CEOs of highly rated ESG firms are paid significantly higher salaries. High ESG firms are larger, more profitable, and mature firms, facing less risks compared to low ESG rated firms. Although these systematic differences in firm characteristics account for a significant portion of the CEO pays, when we decompose the CEO pays between different ESG groups, there exists a non-trivial residual portion of the unexplained compensation gap that the traditional firm characteristics can not fully explain. About 79.8% of the mean difference is attributable to the firm characteristic part and the residual 20.2% can be ascribed to the ESG group effect. The high ESG firms are more active in using the incentive compensation scheme to discipline managers while the low ESG firms are more conservative in adopting the sensitive incentive pay systems because they are more susceptible to the negative factors such as risk and leverage. As a result, we observe significantly higher pay-performance sensitivities for the high ESG group and the low ESG firms are paid lower than what their firm characteristics prescribe. The ESG rating has an orthogonal part of the explanatory power that contributes to the pay-performance sensitivity over the traditional solvency measure such as credit ratings.

Delegation and Managerial Misreporting: The Role of Incentive Compensation Scheme and Trust in Superior

This study investigates determinants of managers’ misreporting behaviour. Misreporting in this study is defined as managers’ action of withholding or misrepresenting information to their superior for their own benefit. Specifically, this study examines the relationship between delegation of decision rights and incentive compensation scheme on manager’s misreporting behaviour. Furthermore, this study examines the mediating role of incentive compensation scheme on the relationship of delegation of decision rights on manager’s misreporting behaviour. In addition, this study explores the potential informal control of trust in superior in deterring delegated managers engaging in misreporting behaviour. The results from a survey of 145 managers who reside in U.S. show that delegation of decision rights affect manager’s misreporting behaviour directly and indirectly through incentive compensation scheme. Moreover, the results show that trust in superior negatively moderates the relationship between delegation of decision rights and manager’s misreporting behaviour, indicating that high trust in superior can be used as informal control to deter managerial misreporting behaviour.

A study on the incentive compensation structure with payroll tax: A continuous-time principal-agent model

This paper studies a case when the government levies a payroll tax on the employee (agent) of an enterprise. We use a continuous-time principal-agent framework to analyze the impact of the tax on the employee’s working strategy and derive an incentive compensation scheme. The agent is supposed to be aware of his pre-tax and after-tax salary. Under the theory of behavioral economics, loss caused by taxation is taken into consideration. The Hamilton-Jacobi-Bellman (HJB) equation of principal’s profits is derived. By exploiting the HJB equation, we get several properties of the optimal contract. We also perform comparative statics to show our results. The model suggests that the agent’s utility loss enlarges as the tax rate increases. However, an increase in the tax rate does not always decrease principal’s profits.

Human-caused mortality of large carnivores in Iran during 1980–2021

Human-caused mortality is the main cause of death for large carnivores worldwide and has had serious adverse effects on their populations. Detailed quantitative information on potential causes and patterns of mortalities are vital for development of effective conservation strategies. We investigated human-caused large carnivore mortalities across Iran using reports provided by Iran’s Department of the Environment (DOE) during January 1980–January 2021, which comprised 399 mortality instances involving 443 carnivore deaths. Brown bears (Ursus arctos) had the highest frequency of occurrence (30%), followed by striped hyenas (Hyaena hyaena; 24%), and Persian leopards (Panthera pardus saxicolor; 17%). Overall, mortalities related to agricultural (i.e. livestock, or crops including plants, fruits, beehives) loss occurred more frequently (31%) than mortality related to illegal trade (21%) and risk to humans (7%). Specifically, brown bears were killed more frequently due to potential threats to human life and crops, whereas leopards and wolves were killed more often because of livestock depredations. Additionally, leopards were killed more frequently for illegal trade of their skins. We recommend the DOE improve local communities’ attitudes toward large carnivores by promoting conservation education programs and incentive compensation schemes, as well as implement mitigation measures (e.g. wildlife crossing structures or fencing) at road mortality hotspots to prevent unnecessary deaths of large carnivores in Iran.

Optimal Procurement Contract with Cost Overruns

This paper studies the optimal procurement contract in the presence of potential cost overruns. The firm s delivery cost depends on its efficiency-type, which is private information. The delivery cost can take two values: planned or overrun. The lack of cost overruns is considered to be a noisy signal of the firm s effort to properly manage the project. The firm is protected by limited liability. Faced with adverse selection, then moral hazard, we show that the buyer offers a fully pooling incentive scheme to the firm. Moreover, the incentive compensation scheme can be implemented by a pair of fixed-price contracts..

The effect of a budget-based incentive compensation scheme on job performance

PurposeThis study aims to examine the role of trust-in-supervisor and organizational commitment on the relationship between a budget-based incentive compensation scheme and job performance.Design/methodology/approachA survey was conducted involving 120 managers from Australian manufacturing firms listed in the Who’s Who in Business in Australia electronic database. A partial least squares approach was used to assess the psychometric properties of the theoretical model and proposed hypotheses. Data analysis was conducted using WarpPLS Version 5.0.FindingsThe results suggest that the reliance on a high budget-based incentive compensation scheme was found to lead to higher trust-in supervisor, which in turn resulted in higher organizational commitment and improved subordinate job performance.Research limitations/implicationsThis study is subject to the limitations of survey-based research.Practical implicationsThis study may assist top management to better understand the importance of designing an effective budget-based incentive compensation scheme to promote high interpersonal trust and organizational commitment among subordinates. Cultivating a climate of trust may help to enhance interpersonal trust between subordinates and their superior, which in turn may lead to higher levels of organizational commitment and improvement in subordinate job performance.Originality/valueThis paper elucidates and contributes to the existing literature by suggesting that a budget-based incentive compensation scheme can directly affect subordinates’ level of trust in their supervisor, and that trust-in-supervisor can serve as an antecedent to the development and cultivation of subordinates’ commitment to the organization, which in turn improves their job performance.

The Effects of Time Pressure and Tournament Incentive Compensation Schemes on Group Performance in a Creative Setting

The Effects of Time Pressure and Tournament Incentive Compensation Schemes on Group Performance in a Creative Setting

The Design and Success of Stock Options Plans for New Economy Firms in Germany

In recent years, the use of stock options as an incentive compensation scheme has evolved to be one of the most debated topics in the finance literature as well as in the corporate world. The investigations into the option granting practices at a number of U.S. firms, which were accused of fraudulent backdating options, as well as the compensation schemes of top bankers and other top executives during the current financial crisis, heated up this debate even more. Our study contributes to the empirical research on stock option plans (SOPs) by focusing on start-up or 'new economy' firms in Germany. For the 329 firms that went public at the 'Neuer Markt', a special stock market segment for young growth companies in Germany, we find a high popularity of stock options in that more than 90% of all IPOs implemented at least one stock option plan (SOP) at the time of the IPO or later on. These SOPs were broad-based and included rank and file employees as the options' recipients. Our empirical results reveal--at least with hindsight--that accepting stock options as part of an overall salary package did not pay off financially for employees during that time period. Furthermore, the success and performance of the investigated SOPs were influenced by their statutory design and the succession of three different lock-up periods. These made a profitable option exercise for employees very difficult. Our findings question the rationale behind the design, introduction, and implementation of SOPs during the time of the 'Neuer Markt' in Germany at least from the perspective of non-executive employees.

Executive Incentive Compensation and Economic Prosperity

This paper analyzes the existence of a potential link between the prevalence of long term incentive compensation schemes and the economic prosperity of a country. This issue is previously not addressed in the literature. In a panel regression with fixed effects a strongly significant, positive effect is found between growth of GDP/capita in real terms and this prevalence, while controlling for general investment and institutional variables. However, when the 22 countries of the study are divided into European and non-European, the growth effect found for the entire material accrues only to the non-European countries. It is concluded that long term incentive contracts seem to have no effect in the European countries due to labor market and cultural reasons.

Reducing incremental costs associated with the delegation of incentive contracting decisions: An analysis of planning and control decisions in a manufacturing setting in the presence of moral hazard

We compare and contrast two specific regimes involving the centralization and delegation of the incentive contracting decision in manufacturing organizations. In the centralization regime, a single individual simultaneously makes the allocation of demand to production facilities and determines the incentive compensation scheme for the managers at the facilities. Under the delegation regime, the demand allocation is decided upon initially by a superior and the incentive contracting decision is subsequently made by a subordinate, who is neither of the two managers in charge of the production facilities. Using the principal–agent paradigm, which assumes that the managerial efforts are unobservable, we demonstrate that the centralization regime performs no worse than the delegation regime. For situations where strategic or other requirements necessitate firms to opt for the delegation of the incentive contracting decision, we propose a heuristic that significantly increases the likelihood of mimicking the allocation and contracting decisions made under the centralized regime.

A note on the interaction effects of non-financial measures of performance

Using principal-agent analyses, the effect of the interactions between two non-financial measures of performance in an agent’s incentive compensation scheme is studied. The agent can allocate effort between “meeting output targets” and “getting output that needs no rework.” The principal trades off (1) a penalty for not meeting output targets, and (2) cost of reworking output that is defective when initially produced. In a compensation mechanism that includes incentives based on measures of output that needs no rework, as well as total output, it is shown that the agent may respond to an increased weight on output that needs no rework by reducing effort allocated towards it. This occurs when the increased weight on the output that needs no rework is accompanied by a sufficiently steep decrease in the weight on total output in the compensation mechanism, leading to a reduction of all effort, and all output. Numerical analyses and implications for the use of multiple measures of performance-based incentives are provided.

Does It Pay to Implement a Full-Scale EVA Management System?
 Evidence from Brazilian Companies

The goal of this study is to compare and contrast the market performance of Brazilian companies that have implemented a full scale EVA financial management system under Stern Stewart & Co. guidance with that of the broad national stock market index, the Ibovespa index and also a comparison against a portfolio of comparable companies. In the US, several academic papers have been published on this matter, showing the better performance of companies that have adopted the EVA system against a benchmark performance, usually the S&P 500, a group of peer companies in the same industry or an industry-specific index. In one of these studies, Prof. Robert Kleinman, from Oakland University, shows that the stock performance of Stern Stewart's EVA companies is 9% per year better, on average, than their industry peers. Moreover, he found that substantial improvements in EBITDA and operating margins, faster asset turns and stronger cash flow generation are the drivers of the superior performance. In another much cited paper, Wallace (1997) attests the superior operating performance of companies that have an EVA metric system linked with their incentive compensation schemes. This is the first attempt ever to carry out such empirical study in Brazil and, despite the relatively small number of listed companies in the sample, the conclusions are robust and worth further investigation. The major findings show the better performance of the portfolio containing EVA companies (EVA Index) against the market index and against the comparables portfolio both on a Total Return-only basis and on a Risk-Adjusted Performance basis (we are using Leah and Franco Modigliani's Risk-Adjusted Performance Measure definition - from now on called RAP). It is important to mention that the results should not be interpreted as a recommendation of any particular trading strategy based on picking companies that implement the EVA Financial Management System. Rather, we believe that the results suggest that the local capital market starts to differentiate and to look positively to companies that implement EVA, which may also be viewed as a proxy for an improved Internal Corporate Governance System.

Managerial Hedging and Incentive Compensation in Stock Market
 Economies

Suppose risk-averse managers can hedge the aggregate component of their exposure to firm's cash flow risk by trading in financial markets, but cannot hedge their firm-specific exposure. This gives them incentives to pass up firm-specific projects in favor of standard projects that contain greater aggregate risk. Such risk substitution is a form of moral hazard and it gives rise to excessive aggregate risk in stock markets and excessive correlation of returns across firms and sectors, thereby reducing risk-sharing among stock market investors. An incentive compensation scheme specifying the managerial equity ownership of the firm can be designed to mitigate this moral hazard. We show that the optimal contract might require a dampening of pay-performance sensitivity, whereby managerial ownership is smaller than in absence of this moral hazard. We characterize the resulting endogenous relationship between managerial ownership and (i) the extent of aggregate risk in the firm's cash flows, as well as (ii) firm value. We show that these endogenous relationships can help explain the shape of the empirically documented relationship between ownership and firm performance.

EXECUTIVE INCENTIVE COMPENSATION SCHEMES AND THEIR IMPACT ON CORPORATE PERFORMANCE: EVIDENCE FROM NEW ZEALAND SINCE COMPENSATION DISCLOSURE REQUIREMENTS BECAME EFFECTIVE

Incentive‐based executive compensation is regarded as a mechanism for alleviating agency problems between executives and shareholders. Seventy‐three New Zealand (NZ) listed companies are used to examine the relationship between executive incentive compensation schemes (ICS) and firm performance. The results suggest that neither compensation level nor adoption of an ICS are significantly related to returns to shareholders or ROA. However, there is a statistically significant relationship between Tobin's q and both CEO compensation and executive share ownership. Further, the evidence suggests the recent compensation disclosure requirements in NZ are not yet stringent enough to allow adequate analysis of the link between ICSs and corporate performance.

Executive Incentive Compensation Schemes and their Impact on Corporate Performance: Evidence from New Zealand Since Legal Disclosure Requirements Became Effective

For many years, executive compensation has been regarded as an internal mechanism to alleviate the agency problems between executives and shareholders. Using a sample of 73 New Zealand listed companies (1994-1998), this paper examines the current state of executive compensation in New Zealand and the relationship between executive incentive compensation and firm performance. The empirical results concerning the relationship between executive compensation and corporate performance indicate that company size and business risk are important factors affecting executive compensation level. The results also show that neither compensation level nor the adoption of an incentive compensation scheme (ICS) are significantly related to corporate performance. However, the relationship between Tobin's q and executive share ownership is found to be strong and statistically significant, while the relationship is found to be insignificant when ROE and ROA are used as a proxy for corporate performance. These negative results suggest that the design of the executive compensation contract has not yet contributed to the reduction of agency costs for companies in New Zealand.

Accounting information, salesforce compensation and acquisition of new customers

The need for the management accounting system (MAS) to support marketing decisions has been identified in literature and practice. Accordingly, several improvements have been suggested with the main intention of providing more detailed information on marketing segments. Yet, even with respect to these improved systems it has to be acknowledged that the quality of the information provided will not be identical for all marketing segments: it can be assumed that it will be more precise for existing segments, which are already served by the firm, than for new ones, with which the firm has comparatively little experience. Further, it has to be considered that the MAS will seldom be the only source of useful information, as the example of the good salesforce having gained a ‘deep understanding’ of the market while doing his job shows. A problem arises if the acquisition of this additional information is (personally) costly and unobservable and therefore has to be motivated by incentive compensation schemes. This paper emphasizes that standard compensation contracts, as recommended by literature and practice, may fail to induce goal-congruent behaviour. It is shown that ranking commission rates according to the profitabilities reported by the MAS may be dysfunctional and that a non-intuitive rank order may be necessary to motivate the salesforce to become better informed and to use this knowledge appropriately.

A Unified Model of Corporate Acquisitions and Divestitures: An Incentive Perspective

The purpose of this paper is to unify corporate acquisitions and divestitures (e.g., spin-offs, equity carve-outs and sell-offs) into a simple but comprehensive agency model where risk and managerial incentives interact to determine an optimal corporate governance and an incentive compensation scheme. Emphasizing human and nonhuman aspect of corporate assets, the model not only explains existing empirical evidence regarding contractual and organizational changes, but also suggests new perspective regarding firms' behavior around corporate acquisitions and divestitures. Thus, it attempts to reconcile between synergistic and agency viewpoints in the takeover literature and provides determining factors in choosing between spinoffs and equity carve-outs.

A classroom exercise on executive incentive compensation schemes

AbstractThis paper describes a classroom exercise that has been used in several graduate courses. The exercise provides the students with a framework for understanding the rationale behind some of the mechanisms we observe in reality: incentive compensation plans for executives, Generally Accepted Accounting Principles (GAAP), auditing, and lawsuits against auditors. As such, the exercise provides some answers for several questions of ‘why’ before getting into the ‘how’ of reporting. The case can be used in courses dealing with financial accounting, managerial control and microeconomics in the MBA level.

Incentive compensation schemes: Experimental calibration of the rationality hypothesis*

Abstract. Behavior inconsistent with expected utility maximization is widely observed and explanations for it abound. The purpose of this research is to identify conditions under which choice behavior is most likely to be consistent with EUM predictions, in order to ensure the successful implementation of economic prescriptions derived under the assumption of EUM rationality. Specifically, a laboratory experiment is used to test the hypothesis that the distinctness between alternatives in a menu of contracts is crucial in determining the likelihood that agent choices are consistent with EUM predictions, and consequently, in the case of incentive compatible contracts, leads to accurate revelation of private information. The results support this hypothesis.Résumé. L'on observe fréquemment des comportements incompatibles avec la maximisation espérée de l'utilité, et les explications à ce sujet foisonnent. L'étude qui suit a pour but de déterminer dans quelles conditions le comportement de choix est le plus susceptible d'être conforme aux prédictions relatives à la maximisation espérée de l'utilité (MEU), et de garantir ainsi le succès de l'implantation des prescriptions économiques dérivées de l'hypothèse de la rationalité de la MEU. De façon plus précise, l'auteure procède à une expérience de laboratoire pour vérifier l'hypothèse selon laquelle la clarté des différentes possibilités d'un menu de contrats est cruciale dans la détermination de la probabilité que les choix du mandataire soient conformes aux prédictions relatives à la MEU et qu'en conséquence, dans le cas de contrats qui se prêtent à l'application de mesures d'incitation, cette clarté ne masque pas la révélation de la véritable information privilégiée. Les résultats de l'étude confirment cette hypothèse.

Discussion of “Incentive compensation schemes: Experimental calibration of the rationality hypothesis”

Discussion of “Incentive compensation schemes: Experimental calibration of the rationality hypothesis”