The Effect of Local Tournament Incentives on Firms’ Performance, Risk-Taking Decisions, and Financial Reporting Decisions
71 Pages Posted: 6 Jul 2016 Last revised: 23 Jun 2019
Date Written: November 1, 2017
This study documents the existence of local employment preferences for corporate executives and examines how the compensation of executives’ local peers affects their own performance, risk-taking decisions, and financial reporting decisions. We find that external hires of new CEOs (CFOs) are five (eight) times more likely to be from local firms than non-local firms. We also find that local tournament incentives—as proxied by the pay gap between an executive and higher-paid executives in the area—are associated with stronger performance, greater risk taking, and more financial misreporting. We find consistent results using a difference-in-difference analysis that exploits plausibly exogenous variation in local tournament incentives caused by the sudden death of a local CEO. Our findings are consistent with executives taking actions to compete for a promotion to a nearby firm with higher pay. In addition, we find the effect of local tournament incentives is larger when local mobility is greater and executives’ local preferences are stronger.
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