Managerial Compensation in Multi-Division Firms

Abstract:     
While literature has highlighted how agency problems between division managers (DM) and the CEO in multi-division firms can distort capital allocation, it has largely ignored the role of DM incentive contacts in resolving these problems. For the first time in literature, we use hand collected data to study the pay structure of division managers (DM). Using data on 4,080 DM-year pay contracts, we relate DM pay to the performance of both her division and other divisions in the firm. Consistent with the idea that the actions of a DM can impose externalities on the rest of the firm, we find that DM pay loads positively on both her division's and the other divisions' performance. Consistent with differences in their spheres of influence we find that the pay for other divisions' performance is significantly greater for the firm's CEO. While CEO pay is equally sensitive to the performance of all divisions in the firm, DM pay is more sensitive to her division's performance as compared to the performance of other divisions. Further, pay for division performance is lower in industries with less informative accounting earnings. This highlights an important cost of conglomeration. The sensitivity of DM pay to other divisions' performance is especially greater, for related divisions and for divisions with fewer growth opportunities as measures by industry Tobin's q and past division sales growth. Focusing on economic conditions, we find that the sensitivity of DM pay to both the performance of her division and other divisions is lower during economic downturns and periods of economic distress. Overall, our evidence suggests that DM compensation is structured to solve agency problems in multi-division firms and reflects the constraints in the contracting environment.

Number of Pages in PDF File: 45

Keywords: conglomerates, division managers, incentive contracts

JEL Classification: G30, J31

working papers series