Pay-for-Performance and Firm Diversification

37 Pages Posted: 2 Jun 1997

See all articles by Thomas W. Bates

Thomas W. Bates

Arizona State University - Department of Finance

Michael L. Lemmon

University of Utah - Department of Finance

John M. Bizjak

Texas Christian University

Date Written: March 1997

Abstract

We find that CEO compensation is less sensitive to stock-price performance the greater the extent of firm diversification. Our empirical evidence is consistent with a theory of managerial entrenchment as well as with a theory of optimal contracting between shareholders and managers. To distinguish between the theories we examine the association between firm value and the structure of the compensation contract along with the use of alternative governance mechanisms in diversified firms. We find only a weak relation between the sensitivity of compensation to stock-price performance and the size of the value loss from diversification. Moreover, we find that the use of alternative governance mechanisms is not suppressed in diversified firms. Our results appear to be more consistent with optimal contracting, and suggest that the existence and magnitude of the diversification discount cannot be attributed to agency problems between managers and shareholders.

JEL Classification: G30, G32, J44

Suggested Citation

Bates, Thomas W. and Lemmon, Michael L. and Bizjak, John M., Pay-for-Performance and Firm Diversification (March 1997). Available at SSRN: https://ssrn.com/abstract=41841 or http://dx.doi.org/10.2139/ssrn.41841

Thomas W. Bates (Contact Author)

Arizona State University - Department of Finance ( email )

W. P. Carey School of Business
PO Box 873906
Tempe, AZ 85287-3906
United States

Michael L. Lemmon

University of Utah - Department of Finance ( email )

David Eccles School of Business
Salt Lake City, UT 84112
United States
801-585-5210 (Phone)
801-581-7214 (Fax)

John M. Bizjak

Texas Christian University ( email )

Fort Worth, TX 76129
United States
817-257-4260 (Phone)

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