Bonus Rigidity and Future Performance: Theory and Evidence

46 Pages Posted: 7 May 2012

See all articles by William M. Cready

William M. Cready

University of Texas at Dallas - Naveen Jindal School of Management

Zhonglan Dai

University of Texas at Dallas - School of Management

Guang Ma

McGill University - Desautels Faculty of Management

Date Written: April 30, 2012

Abstract

Drawing on the extensive economics literature on wage rigidity, we examine CEO bonus rigidity and, in particular, the implications of downward bonus rigidity for future performance. We first document distributional support for downward rigidity in bonus payments. More importantly, we find that bonus cuts have distinct negative implications for future firm performance. Indeed, our evidence indicates that bonus rigidity is the primary driver of the positive relation between unexpected cash compensation and future performance documented by Hayes and Schaefer (2000). Our evidence is also broadly consistent with morale theories of pay rigidity (Bewley, 1995, 2002; Yellen, 1984) which posit that employers avoid reducing nominal wages due to the adverse impact that such cuts have on employee morale. This relation in turn suggests that morale consequences are an important factor in management compensation committee decisions to shield pay from adverse performance outcomes such as losses (Dechow et al., 1994; Gaver and Gaver, 1998).

Keywords: Bonus Compensation, Performance Prediction, Compensation Shielding, Pay Rigidity

JEL Classification: E24, J3, M49

Suggested Citation

Cready, William M. and Dai, Zhonglan and Ma, Guang, Bonus Rigidity and Future Performance: Theory and Evidence (April 30, 2012). Available at SSRN: https://ssrn.com/abstract=2053338 or http://dx.doi.org/10.2139/ssrn.2053338

William M. Cready (Contact Author)

University of Texas at Dallas - Naveen Jindal School of Management ( email )

P.O. Box 830688
Richardson, TX 75083-0688
United States

Zhonglan Dai

University of Texas at Dallas - School of Management ( email )

2601 North Floyd Road
Richardson, TX 75083
United States

Guang Ma

McGill University - Desautels Faculty of Management ( email )

1001 Sherbrooke St W
Montreal, Quebec h3A 1G5
514-398-5075 (Phone)

HOME PAGE: http://guangma.info

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