A Few Bad Apples: An Analysis of CEO Performance Pay and Firm Productivity
66 Pages Posted: 27 May 2008 Last revised: 28 Feb 2010
Date Written: October 1, 2009
We investigate the relationship between CEO performance pay incentives and firm productivity. In general, we find an inverse U-shaped relationship between productivity and the sensitivity of CEO wealth to share value (delta) and a positive relationship between productivity and the sensitivity of CEO option wealth to stock return volatility (vega). Thus, a high delta associated with CEO risk-aversion lowers productivity, but a high vega from stock options offsets this effect. In looking at delta and vega jointly, we also find that options do not always achieve their intended purpose. These results are stronger among firms that are weakly governed or when high transaction costs prevent the writing of an optimal compensation contract.
Keywords: CEO, Executive Compensation, Pay-Performance Sensitivity, Productivity
JEL Classification: G32, G30, L2, O3
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