Incentive Pay Research Articles

New Evidence On The Structuring Of CEO Incentive Pay Ratios

<p class="MsoNormal" style="text-align: justify; margin: 0in 0.5in 0pt;"><span style="font-family: "CG Times","serif";"><span style="font-size: x-small;">The model examines both determinants of CEO incentive pay ratios that are controllable by the CEO, and those that are less controllable, based on a sample of 316 Fortune 500 firms in 1992. Firm diversity, firm growth opportunities, outside blockholdings, and the number of analysts following the firm were positively related to CEO incentive compensation ratios, while firm unsystematic risk, CEO stockholdings, and industry regulation had a negative impact. Finally, industry-specific influences were evident on incentive compensation ratios.</span></span></p>

Teams, Incentive Pay, and Productive Efficiency: Evidence from a Food-Processing Plant

By using weekly records on efficiency for four production lines in a Finnish food-processing plant during the period 1999–2005, the authors investigate the effects on production line performance once changes in Human Resource Management (HRM) practices were instituted. Using time-series methods to estimate structural change models, the authors were able to determine the extent to which specific HR policies—the introduction of teams, company-wide profit-sharing, and a group system of performance-related pay (PRP)—affected workers' efficiency, even though production technology remained the same. As predicted, the authors found that in three of the four production lines, when PRP was added to teams, productivity increased from between 9 and 20%, highlighting the importance of the complementarity between employee participation and incentive pay.

Institutions and the Management of Human Resources: Incentive Pay Systems in France and Great Britain

AbstractUsing data from large‐scale establishment surveys in Britain and France, we show that incentive pay for non‐managers is more widespread in France than in Britain. We explain this finding in terms of the ‘beneficial constraint’ arising from stronger employment protection in France, which provides an impulse to develop incentive pay; employer networking activities in France, which facilitate joint learning about its development and operation; and government fiscal incentives for profit‐sharing, which reduce the cost of its operation.

The Cross-Section of Stock Returns and Incentive Pay

We find evidence that Chief Executive Officer (CEO) pay is negatively related to future stock returns for periods up to three years after sorting on pay. For example, firms that pay their CEOs in the top ten percent of excess pay earn negative abnormal returns over the next three years of approximately -8%. The effect is stronger for CEOs who receive higher incentive pay relative to their peers and stronger for CEOs with greater tenure. Our results appear to be driven by high-pay related CEO overconfidence that leads to shareholder wealth losses from activities such as overinvestment and value-destroying mergers and acquisitions.

Reciprocity and Incentive Pay in the Workplace

This discussion paper has resulted in a publication in the Journal of Economic Psychology , 31(4), 676-686. We study optimal incentive contracts for workers who are reciprocal to management attention. When neither worker's effort nor manager's attention can be contracted, a double moral-hazard problem arises, implying that reciprocal workers should be given weak financial incentives. In a multiple-agent setting, this problem can be resolved using promotion incentives. We test these predictions using German Socio-Economic Panel data. We find that workers who are more reciprocal are significantly more likely to receive promotion incentives, while there is no such relation for individual bonus pay.

Compensating for Executive Compensation: The Case for Gatekeeper Incentive Pay

[E]xecutive compensation abruptly shifted in the United States during the 1990s, moving from a cash-based system to an equity-based system. More importantly, this shift was not accompanied by any compensating change in corporate governance to control the predictably perverse incentives that reliance on stock options can create. 1

The Effects of Litigation Risk on Board Oversight and CEO Incentive Pay

Various commentators have praised the WorldCom and Enron settlements for holding outside directors personally liable, arguing that heightened director liability will induce greater board oversight. This paper shows that the connection between director liability and board behavior is more subtle, because directors have multiple means to respond to an increase in liability exposure: They can increase oversight to prevent accounting manipulation and/or reduce performance-based CEO pay to mitigate the CEO's ex ante incentive to engage in manipulation. These two decisions are interrelated, implying that the effects of director liability on board oversight and CEO incentive pay are ambiguous. In particular, the model predicts that, for firms in which board oversight is difficult and costly (e.g., large firms with complex business operations), a stricter legal environment for directors leads to a lower level of board oversight, lower CEO incentive pay, and lower shareholder value.

Incentive Pay for CEOs in Cooperative Firms

Cooperative owners have a transactional relationship as customers or input suppliers with their rm in addition to their investment relationship. This changes both the incentives and the information that owners have to monitor managerial performance. We argue that this di erence reduces the need for cooperative CEOs to receive performance-based pay, relative to CEOs in other kinds of organizations. We conduct 9 interviews of cooperative CEOs to informally test our hypothesis. Although our sample is small, results strongly support our hypothesis: in every case but one, the CEOs we spoke with face a mostly subjective and discretionary pay system. Our results also reveal that, while cooperative CEOs are subject to intense supervision by the board, they enjoy a relative independence in devising rm strategy. This nding is consistent with the notion that cooperative owners may be informationally advantaged on some dimensions (e.g., monitoring diligence), but informationally disadvantaged on others.

A Better Renewable Portfolio Standard

It's time to throw out our RPS, throw out our Energy Efficiency Resource Standard, throw out all our definitions of eligible technologies, and replace them all with a single, clear incentive paid to any power plant that reduces our demand for fossil resources, pro rata with the fossil energy reduction: a Fossil Energy Reduction Standard.

Mutual Monitoring Versus Incentive Pay in Teams

Agents who work in teams may be better informed about each other's effort than the employer. We analyse how the possibility for employees to write contracts on this information alters the incentives provided by the principal. We show that side-contracting is profitable for the employer when agents are well informed and hardly constrained by a limited liability. Furthermore, we show that mutual monitoring dominates unilateral supervision for high values of the monitoring cost.

Incentive Pay for CEOs in Cooperative Firms

Cooperative owners have a transactional relationship - as customers or input suppliers - with their firm in addition to their investment relationship. This changes both the incentives and the information that owners have to monitor managerial performance. We argue that this difference reduces the need for cooperative CEOs to receive performance-based pay, relative to CEOs in other kinds of organizations. We conduct 9 interviews of cooperative CEOs to informally test our hypothesis. Although our sample is small, results strongly support our hypothesis: in every case but one, the CEOs we spoke with face a mostly subjective and discretionary pay system. Our results also reveal that, while cooperative CEOs are subject to intense supervision by the board, they enjoy a relative independence in devising firm strategy. This finding is consistent with the notion that cooperative owners may be informationally advantaged on some dimensions (e.g., monitoring diligence), but informationally disadvantaged on others.

Reciprocity and Incentive Pay in the Workplace

We study optimal incentive contracts for workers who are reciprocal to management attention. When neither worker's effort nor manager's attention can be contracted, a double moral-hazard problem arises, implying that reciprocal workers should be given weak financial incentives. In a multiple-agent setting, this problem can be resolved using promotion incentives. We test these predictions using German Socio-Economic Panel data. We find that workers who are more reciprocal are significantly more likely to receive promotion incentives, while there is no such relation for individual bonus pay.

Effects of Litigation Risk on Board Oversight and CEO Incentive Pay

Various commentators have praised the WorldCom and Enron settlements for holding outside directors personally liable, arguing that heightened director liability will induce greater board oversight. This paper shows that the connection between director liability and board behavior is more subtle, because directors have multiple means to respond to an increase in liability exposure: They can increase oversight to prevent accounting manipulation and/or reduce performance-based CEO pay to mitigate the CEO's ex ante incentive to engage in manipulation. These two decisions are interrelated, implying that the effects of director liability on board oversight and CEO incentive pay are ambiguous. In particular, the model predicts that, for firms in which board oversight is difficult and costly (e.g., large firms with complex business operations), a stricter legal environment for directors leads to a lower level of board oversight, lower CEO incentive pay, and lower shareholder value.

Empirical analysis of the efficiency of job assignment auctions

For some hard-to-fill jobs the Navy awards Assignment Incentive Pay using an auction-like format. With respect to the optimal job assignment auction format, however, there is only a very limited academic literature. Furthermore, the extant literature assumes all bidders are equally qualified. In the Navy assignment context, this is not a tenable assumption, as other considerations, such as relocation and en-route training costs, must be considered when making an assignment. The lower the weight on the bid, the greater the weight that can be attached to the qualification component in the objective function. The lower the weight, however, the weaker the incentive to bid near one's reservation wage. The consideration of such other criteria precludes the implementation of the incentive-compatible, Vickery–Leonard assignment auction. We relax the assumption that bid amounts alone determine the assignment set and experimentally estimate the efficiency reductions associated with decreased bid-weights. The estimated elasticity of the value of the bids to changes in the bid-weight in low contention, first price auctions vary by bid-weight. Nonetheless, an increase from a 10 to a 50% weight on the bids decreases the level of the submitted bids by approximately 28%.

Evaluation of Subjectivity in Incentive Pay

The study aims to investigate the determinants of subjective bonus payouts in the UK financial industry. Bonuses are increasingly linked to wider business goals, such as quality and customer service, firm reputation and employee hiring and retention policies, thus replacing the traditional focus on output or profit measures. A new conceptual work on subjectivity is used to evaluate these bonus practices. Results indicate that a variety of contextual factors have influenced the firms to make greater use of subjectivity in bonus payouts. Of these, organizational interdependency appeared to be the most forceful factor, followed by management’s strategic focus, long-term investment in intangibles, economic constraints, performance target difficulty, and competition. The analysis suggests that subjectivity acts as a mechanism that aligns the interests of individual employees with the firm’s performance goals. The study also draws attention to the costs of subjectivity in performance evaluation.

Out of Options? Optimal Incentive Pay and Corporate Strategy Dynamics

Good managers can give firms a competitive edge with respect to their industry rivals. This paper studies how shareholders design executive compensation contracts optimally - i.e., how they provide incentives - to exploit the competitive effect of managerial skills. A central assumption is that managerial skills, although identical ex-ante, evolve over time as managers build a track record, i.e. a history of successes or failures. Since it takes time to build up a successful track record, competition among firms is dynamic, in that laggards with relatively inexperienced managers must first catch-up with the leading edge managers before battling for leadership in the future. Incentives that optimally exploit dynamic competition imply an inverse relation between the magnitude of performance-based pay and, (i) across industries, the degree of symmetry of industry structure; (ii) within industry, firm position with respect to its peers. Empirical estimates for a large sample of U.S. executives over the 1993 to 2004 period provide strong support for these predictions. Overall, dynamic competition offers a novel rationale for the increased reliance of top executive pay on high-powered incentives, such as bonuses and stock options, over the 1990s.

Incentive Pay, Fraud, and Self-Reported Performance Measures

Executives generally receive incentive pay based on accounting metrics reported by the executives themselves and not otherwise directly observable. The recent prevalence of accounting scandals has led many researchers and practitioners to question the wisdom of these incentive packages. In this paper, I explore the impact of self-reported performance measures by analyzing a principal-agent model in which the principal cannot observe performance directly but instead relies on the agent to report results. In the basic model, I show that optimal incentive pay is lower when self-reporting is used, thereby providing a novel reason why incentive pay is typically lower than other principal-agent models predict. The model also provides a justification for the common practice of making bonus pay proportional to salary. In an extended model with multiple agent types, I show that under some assumptions, the optimal contract provides incentive for almost all agents to falsify results. Under other assumptions, one can replace any such contract with one that relies solely on externally verifiable data, without loss of profit. This model contributes new insights into the advantages of highly leveraged firms such as LBOs. Finally, an extended model with a private benefit for truth telling predicts the observed positive correlations between incentive pay, fraud, and industry or growth rate. Overall, the model contributes towards the current debate over whether incentive pay is too high by offering the following implications. First, incentive pay might be too high if firms overestimate the reliability of performance metrics. Second, fraud might be higher than necessary if firms overlook alternative directly observable metrics. Third, total realized pay might be too high if firms overlook the possibility of imposing fraud fines. Finally, the prevalence of fraud and the positive correlation between fraud and incentive pay can be consistent with an equilibrium model in which firms maximize profits. Thus, these observations alone do not imply that incentive pay is too high.

Measurement Error and Incentive Pay

Abstract. We will analyse the optimal incentive scheme when the risk‐neutral principal contracts with many risk‐averse agents. Each agent produces an individual contribution which jointly form a total output. Agents’ efforts are unobservable and the principal cannot observe individual outputs without an error. Neither the observed individual output of an agent nor the observed total output of the whole team are then sufficient statistics for the actual individual output in the sense of Blackwell. We show that the mixed contract of the pure piece‐rate contract and of the pure team contract then dominates the pure contracts from the principal's point of view.

Innovation, Endogenous Overinvestment, and Incentive Pay

We analyze how two of the key tasks of (division) managers interact: the task to grow the business by creating new investment opportunities and the task to provide accurate information about these opportunities in the corporate budgeting process. We show how the interaction of these two tasks endogenously biases managers towards overinvesting in their own projects. This bias is further exacerbated if managers have to compete for limited corporate resources in an internal capital market. We find that only a sufficiently steep compensation scheme can mitigate or even overcome this bias. Our theory generates several novel implications linking the use of compensation schemes and corporate investment decisions.

Using Incentive Pay and Providing Pay Supplements in U.S. Job Markets

This article investigates whether the earnings premium found with use of incentive pay is offset by lower supplemental pay. More comprehensive measures of employer costs for employee compensation are used to test the hypothesis. These data indicate that bonuses, overtime work, pension provision, and shift differentials can be less common in jobs with incentive pay, but the lower incidence of these forms of compensation does not offset the higher earnings associated with incentive pay.