Compensation Gaps Among Top Executives: Evidence of Tournament Incentives or Productivity Differentials?
58 Pages Posted: 15 Mar 2012
Date Written: February 1, 2012
We explore the determinants of the compensation gaps between the CEO and other senior executives by comparing two competing theories based on optimal contracting, namely tournament theory and productivity theory. We find little evidence that firms design their executive compensation policies in manner consistent with tournament theory. Our strongest evidence against tournament theory is found when a succession contest is most likely to occur, such as prior to CEO turnovers and CEO retirements in particular, and also in firms that are most likely to conduct a contest for selecting their next CEO. Empirically, we find that tournament predictions have weak explanatory power in these samples. In contrast, we find substantial evidence that executive compensation is strongly linked to measures of senior executive productivity, and that productivity differentials among senior executives explain a large part of firm compensation gaps.
Keywords: compensation gap, executive compensation, tournament, productivity, agency theory
JEL Classification: J30, J33, G35
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