The Role of Executive Cash Bonuses in Providing Individual and Team Incentives

Abstract

Given CEOs’ substantial equity portfolios, much recent literature on CEO incentives regards cash-based bonus plans as largely irrelevant, begging the question of why nearly all CEO compensation plans include such bonuses. We develop a new measure of bonus plan incentives, and document that performance sensitivities are much greater than prior estimates. We also test hypotheses regarding the role of bonuses in providing executives with individualized and team incentives. We find little evidence supporting the individualized incentives hypotheses, but consistent evidence that bonus plans appear to be used to encourage mutual monitoring and to facilitate coordination across the top management team as a whole.

Keywords: executive compensation, managerial incentives, pay-performance sensitivity

JEL Classification: G34, J33, M12