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Discretion in Executive Incentive Contracts: Theory and Evidence

49 Pages Posted: 27 Dec 2001  

Kevin J. Murphy

University of Southern California - Marshall School of Business; USC Gould School of Law

Paul Oyer

Stanford Graduate School of Business; National Bureau of Economic Research (NBER)

Date Written: December 2001

Abstract

We examine the role of discretion in executive incentive contracts, and explore the trade-offs firms face in choosing among imperfect objective measures of individual performance, potentially more accurate but non-verifiable subjective measures, and overly broad objective measures of company-wide performance that include the performance of all agents in the firm. We generate implications and test the model empirically using a proprietary dataset of executive bonus plans. Consistent with our model, we find that discretion is less important in determining CEO pay than the pay of other executives. We also find that discretion is relatively important in determining executive bonuses at larger and privately held firms and that more diversified firms are relatively less likely to compensate their business unit managers based on firm-wide performance. Finally, we consider (and largely dismiss) tax-related explanations for our results.

Keywords: Discretion; Subjective performance valuation; Executive compensation

JEL Classification: J44, J33

Suggested Citation

Murphy, Kevin J. and Oyer, Paul, Discretion in Executive Incentive Contracts: Theory and Evidence (December 2001). Available at SSRN: https://ssrn.com/abstract=294829 or http://dx.doi.org/10.2139/ssrn.294829

Kevin J. Murphy

University of Southern California - Marshall School of Business ( email )

BRI 308, MC 0804
Los Angeles, CA 90089-0804
United States
213-740-6553 (Phone)
213-740-6650 (Fax)

USC Gould School of Law

699 Exposition Boulevard
Los Angeles, CA 90089
United States

Paul Oyer (Contact Author)

Stanford Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305-5015
United States
650-736-1047 (Phone)
650-725-0468 (Fax)

National Bureau of Economic Research (NBER)

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Cambridge, MA 02138
United States

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