Incentive Pay Prior to CEO Turnover When Effort Choices Have Lasting Effects

26 Pages Posted: 3 Feb 2022

See all articles by Dmitriy Chulkov

Dmitriy Chulkov

Indiana University Kokomo - School of Business

John Barron

Purdue University - Department of Economics

Date Written: February 2, 2022

Abstract

We present a modified principal-agent model to identify a link between the anticipated likelihood of future CEO turnover and the optimal sensitivity of incentive pay to firm performance. The analysis focuses on the optimal sequence of standard one-period incentive contracts when CEO effort choices have lasting effects on firm performance. In such a model, an increase in the anticipated likelihood of turnover reduces the impact of future incentive contracts on current CEO effort, and induces a compensatory increase in the optimal sensitivity of current CEO compensation to current firm performance. We find empirical evidence in support of this prediction for a sample of over 3,000 US firms. Using an executive-specific fixed effects model, we find that among CEOs who depart within two years, the sensitivity of current incentive pay to changes in current firm performance is greater when there is a higher anticipated likelihood of CEO turnover as proxied by departures that reflect a planned succession and departures by CEOs who have reached retirement age. As expected, this increase in the sensitivity of current incentive pay to changes in firm performance is not found if the subsequent turnover is classified as unplanned, and thus not anticipated by the firm.

Keywords: Executive Compensation, CEO turnover, Incentive pay, Planned succession

JEL Classification: G30, J33, J63, M12, M52

Suggested Citation

Chulkov, Dmitriy and Barron, John M., Incentive Pay Prior to CEO Turnover When Effort Choices Have Lasting Effects (February 2, 2022). Available at SSRN: https://ssrn.com/abstract=4024448 or http://dx.doi.org/10.2139/ssrn.4024448

Dmitriy Chulkov (Contact Author)

Indiana University Kokomo - School of Business ( email )

2300 S Washington
P.O. Box 9003
Kokomo, IN 46904-9003
United States

John M. Barron

Purdue University - Department of Economics ( email )

West Lafayette, IN 47907-1310
United States
765-494-4451 (Phone)
765-494-9658 (Fax)

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