Performance Pay Plans, Power and Product Prices

Abstract

Using a high-granularity dataset containing retail prices for ∼300,000 products spanning ∼1,000 narrowly-defined product categories, I examine how product prices relate to the performance metrics used in CEO pay plans. Firms with large market shares reduce their product prices when the CEO is compensated on the basis of: (1) accounting-based relative performance evaluation ("RPE") and/or (2) performance metrics that shield the CEO from expenses (e.g., sales or EBITDA). Price reductions occur sharply around the adoption of accounting-based RPE, but occur slowly around the adoption of sales-based pay. Price reductions with accounting-based RPE are most pronounced in product categories where firms compete directly against their RPE peers. The high granularity of the dataset allows for a tight empirical design that rules out many non-causal explanations. Collectively, this evidence is consistent with a large body of theoretical work which shows that RPE and cost shielding encourage competitive aggression, and thereby suggests that the performance metrics used in CEO pay plans can have important implications for customers, competitors, supply-chain partners and potentially antitrust authorities.

Keywords: Executive Compensation, Product Market Competition, Pricing, Relative Performance Evaluation, Cost Shielding JEL Codes: D41, D43, L11, L13, M12, M52

JEL Classification: D41, D43, L11, L13, M12, M52