Explaining Pay without Performance: The Tournament Alternative

47 Pages Posted: 15 Feb 2008

See all articles by Iman Anabtawi

Iman Anabtawi

University of California, Los Angeles (UCLA) - School of Law


After only a brief hiatus in the wake of the stock market downturn of 2000, Chief Executive Officer (CEO) pay levels have resumed their upward trajectory. In response, many influential shareholders and academics are asking the question: Are the executive compensation arrangements we observe examples of optimal contracting between CEOs and the boards of directors of the firms they manage, according to which executives are rewarded for enhancing shareholder value? Or do such arrangements indicate a corporate governance failure, whereby CEOs exercise so much influence over boards that managers are effectively setting their own pay?

The foregoing accounts - optimal contracting and managerial power, respectively - dominate current explanations of how executive pay is structured. In this Article, I demonstrate that neither explains adequately observed executive pay arrangements. Instead, I turn to the paradigm of tournament theory-in which CEO pay is a prize awarded to the winner of a competition to get to the top of the corporate ladder; to illuminate the structure of executive pay. Introducing tournament theory into the mix of how firms motivate their CEOs can explain features of CEO pay that are either inconsistent with, or deemed inefficient by, competing theories. Because one's view of how executive pay arrangements should be designed has significant implications for our assessment of actual executive pay practices, I argue that we should consider the role that tournaments can play in motivating executives before undertaking reforms in the executive pay arena.

Optimal contracting theory, in which boards of directors are assumed to be designing pay-for-performance contracts to align the interests of managers with those of shareholders, remains the dominant lens through which executive pay arrangements are analyzed. Observed executive pay contracting fails, however, to conform to the optimal contracting model. Rather than linking compensation to performance, pay arrangements for executives do not reveal a statistically significant relationship between the two. This anomaly has puzzled scholars in the executive compensation area and generated a vigorous debate over pay without performance.

Keywords: executive compensation, optimal contracting, managerial power, executive pay structure, tournament theory

Suggested Citation

Anabtawi, Iman, Explaining Pay without Performance: The Tournament Alternative. Emory Law Journal, Vol. 54, p. 1557, 2005, UCLA School of Law, Law-Econ Research Paper No. 08-03, Available at SSRN: https://ssrn.com/abstract=1092621

Iman Anabtawi (Contact Author)

University of California, Los Angeles (UCLA) - School of Law ( email )

385 Charles E. Young Dr. East
Room 1242
Los Angeles, CA 90095-1476
United States

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Abstract Views
PlumX Metrics