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http://ssrn.com/abstract=687504
 
 

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Are Incentive Contracts Rigged by Powerful CEOs?


Adair Morse


University of California, Berkeley - Haas School of Business

Vikram K. Nanda


Georgia Institute of Technology - College of Management

Amit Seru


University of Chicago - Booth School of Business and NBER

November 2008

AFA 2006 Boston Meetings Paper
EFA 2006 Zurich Meetings Paper

Abstract:     
We argue that powerful CEOs induce their boards to shift the weight on performance measures towards the better performing measures, thereby rigging the incentive part of their pay. The intuition is developed in a simple model in which some powerful CEOs exploit superior information and lack of transparency in compensation contracts to extract rents. The model delivers an explicit structural form for the rigging of CEO incentive pay along with testable implications that rigging is expected to (1) increase with CEO power; (2) increase with CEO human capital intensity and uncertainty about a firm's future prospects; and (3) negatively impact firm performance. Using measures of CEO power and board independence on a large panel of firms in the U.S., we find support for these predictions. Rigging accounts for 10%-30% of the sensitivity of compensation to performance measures and is increasing in CEO human capital and volatility of a firm's future prospects. Moreover, the portion of incentive pay that is predicted by power is associated with negative subsequent future stock performance of the order of 1% and operating performance of 5% per year. Overall, the results provide evidence against the agency substitution theory and support instead the entrenchment skimming theory.

Number of Pages in PDF File: 49

Keywords: CEO Power, Incentive Contracts, CEO Compensation, Board of Directors, Governance, Rent Extraction

JEL Classification: J33, J31, G34

working papers series


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Date posted: March 22, 2005 ; Last revised: November 12, 2008

Suggested Citation

Morse, Adair and Nanda, Vikram K. and Seru, Amit, Are Incentive Contracts Rigged by Powerful CEOs? (November 2008). AFA 2006 Boston Meetings Paper; EFA 2006 Zurich Meetings Paper. Available at SSRN: http://ssrn.com/abstract=687504 or http://dx.doi.org/10.2139/ssrn.687504

Contact Information

Adair Morse
University of California, Berkeley - Haas School of Business ( email )
545 Student Services Building
Berkeley, CA 94720
United States
Vikram K. Nanda (Contact Author)
Georgia Institute of Technology - College of Management ( email )
800 West Peachtree St., NW
Atlanta, GA 30308-1149
United States
404-385-8156 (Phone)
Amit Seru
University of Chicago - Booth School of Business and NBER ( email )
5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

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