Selection Versus Incentives in Incentive Pay: Evidence from a Matching Model
44 Pages Posted: 4 Jun 2018 Last revised: 1 Oct 2019
Date Written: June 4, 2018
Higher incentive pay is associated with better firm performance. I introduce a model of CEO-firm matching to disentangle the two confounding effects that drive this result. On one hand, higher incentive pay directly induces more effort; on the other hand, higher incentive pay indirectly attracts more talented CEOs. I find both effects are essential to explain the result, with the selection effect accounting for 12.7% of the total effect. The relative importance of the selection effect is the largest in industries with high talent mobility and in more recent years.
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