Sorting Effects of Performance Pay

37 Pages Posted: 10 Aug 2013

See all articles by Maris Goldmanis

Maris Goldmanis

University of London, Royal Holloway College - Department of Economics

Korok Ray

Texas A&M University

Multiple version iconThere are 2 versions of this paper

Date Written: August 6, 2013


Compensation not only provides incentives to an existing manager, but also affects the type of manager attracted to the firm. This paper examines the dual incentive and sorting effects of performance pay in a simple contracting model of endogenous participation. In general, sorting dampens optimal pay-performance sensitivity (PPS), as PPS beyond a nominal amount transfers unnecessary (information) rent to the manager. This helps explain why empirical estimates of PPS are much lower than predictions from models of moral hazard alone. The model also predicts that sorting under asymmetric information causes the firm to turn away more candidates than would be efficient; PPS increases in the cost of hiring the manager and in the manager's outside option, but decreases in output risk, information risk, and managerial risk-aversion; the firm becomes more selective in hiring as either the manager's outside option, the cost of hiring, risk-aversion, output risk, or information risk increases.

Keywords: International Accounting, GAAP, IFRS, FASB, IASB

JEL Classification: C70, D00, K12, G34

Suggested Citation

Goldmanis, Maris and Ray, Korok, Sorting Effects of Performance Pay (August 6, 2013). Available at SSRN: or

Maris Goldmanis

University of London, Royal Holloway College - Department of Economics ( email )

Royal Holloway College
Surrey, Surrey TW20 0EX
United Kingdom

Korok Ray (Contact Author)

Texas A&M University ( email )

4113 TAMU College State
TX 77843-4113
United States


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