Growth Options, Incentives, and Pay-for-Performance: Theory and Evidence

52 Pages Posted: 23 Mar 2017 Last revised: 30 Nov 2018

See all articles by Sebastian Gryglewicz

Sebastian Gryglewicz

Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE)

Barney Hartman-Glaser

University of California, Los Angeles (UCLA) - Anderson School of Management

Geoffery Zheng

University of California, Los Angeles (UCLA), Anderson School of Management, Students

Date Written: November 27, 2018

Abstract

Pay-performance sensitivity is a common proxy for the strength of incentives. We show that growth options create a wedge between expected-pay-effort sensitivity, which determines actual incentives, and pay-performance sensitivity, which is the ratio of expected-pay-effort to performance-effort sensitivity. An increase in growth option intensity can increase performance-effort sensitivity more than expected-pay-effort sensitivity so that as incentives increase, pay-performance sensitivity decreases. We document empirical evidence consistent with this finding. Pay-performance sensitivity, measured by dollar changes in manager wealth over dollar changes in firm value, decreases with proxies for growth option intensity and increases with proxies for growth option exercise.

Keywords: Dynamic Contracting, Real Options, Pay-Performance Sensitivity

JEL Classification: D86, D92, G31, G32, M12

Suggested Citation

Gryglewicz, Sebastian and Hartman-Glaser, Barney and Zheng, Geoffery, Growth Options, Incentives, and Pay-for-Performance: Theory and Evidence (November 27, 2018). Available at SSRN: https://ssrn.com/abstract= or http://dx.doi.org/10.2139/ssrn.2938712

Sebastian Gryglewicz

Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE) ( email )

P.O. Box 1738
3000 DR Rotterdam, NL 3062 PA
Netherlands

Barney Hartman-Glaser (Contact Author)

University of California, Los Angeles (UCLA) - Anderson School of Management ( email )

110 Westwood Plaza
Los Angeles, CA 90095-1481
United States

Geoffery Zheng

University of California, Los Angeles (UCLA), Anderson School of Management, Students ( email )

Los Angeles, CA
United States

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