Performance measurement is an essential part of the design of any incentive system. The strength and value of incentives in organizations are strongly affected by the performance measures available. Yet, the characteristics of valuable performance measures have not been well explored in the agency literature. In this paper, I use a multi-task model to develop a two-parameter characterization of performance measures and show how these two parameters—distortion and risk—affect the value and use of performance measures in incentive contracts. I show that many complex issues in the design of real world incentive contracts can be fruitfully viewed as trade-offs between these two features of performance measures. I also use this framework to analyze the provision of incentives in several specific environments, including R&D labs and non-profit organizations.

We examine the distribution of incentives across executives with explicit divisional responsibilities, those with broad oversight authority over the firm, and CEOs. Oversight executives have pay-performance incentives that are $1.22 per thousand dollar increase in shareholder wealth higher than those of divisional executives. For CEOs, incentives are $5.65 per thousand higher than for executives with divisional responsibility. The aggregate pay-firm performance sensitivity of the top management team is substantial, at $32.32 per thousand for the median firm. CEO incentives are 42 to 58 percent of the aggregate incentives to the top management team. We match a subset of our divisional executives to the divisions they manage. We document a positive pay-divisional performance sensitivity and show that it is increasing in the precision of the divisional performance measure. The pay-firm performance sensitivity for divisional executives is decreasing in the precision of their divisional performance measure. These results are consistent with a principal-agent model with multiple signals of managerial effort.

An innovative business practice attributed to the information technology industry is the aggressive use of employee stock options to compensate executives and other employees. The pervasiveness of stock options among high-tech firms in Silicon Valley is often described as a phenomenon unique to the Valley’s culture. In this study, we investigate whether the greater use of stock options in the information technology industry can be explained on the basis of general economic relationships that apply to firms in all industries. Our empirical model is a system of simultaneous equations that captures the interconnectedness between compensation, performance, and specific forms of compensation. We document the impact of the form of compensation on performance and total compensation. Based on previous literature, we also identify economic factors expected to influence the use of stock options and show that there are significant differences between information technology and other industries. While these factors explain much of the greater use of options in the information technology firms, a significant residual difference remains. Considering these factors, we also find that executives in the information technology industry are not compensated at a level higher than those in other industries.

Dissatisfaction with traditional accounting-based performance measures has spawned a number of alternatives, of which Economic Value Added (EVA) is currently the most prominent. How can we tell which performance measures best capture managerial contributions to value? There is currently a heated debate among practitioners as to whether the new performance measures have a higher correlation with stock values and their returns than do traditional accounting earnings. Academic researchers have instead relied on the variance of performance measures to gauge their relative accuracy. To formally address the above debate, we use a relatively standard principal-agent model in which contracts can be based on any two accounting-based performance measures plus the stock price. Rather than model detailed differences between EVA and traditional measures such as earnings, we focus on the problem that while the variability of each measure is observable, their

In this paper we consider a repeated interaction between a manufacturing firm and a subcontractor. The moral hazard problem present in this relationship is aggravated by the fact that both parties do not have perfect knowledge about the base cost level of the project carried out by the subcontractor but only have identical a priori beliefs. Short term and long term contracts are compared in a two-period framework and it is shown that given common uncertainty about the base cost level of the project short term contracts are preferable to long term contracts if the parties can update their beliefs according to incoming information. On the other hand it is demonstrated that long term contracts may be preferable if additional information about the base cost level is received between the periods.

Since alternative forms of compensation have different incentive and risk attributes and may respond differently to observable firm performance measures, analysis of relations between executive pay and performance must consider the interplay between the components of total compensation. In this study, interrelations between compensation components and contemporaneous firm performance measures are considered in an empirical model that relates total compensation to performance through the cash bonus and stock-based shares of total compensation. For this analysis, total compensation and the stock-based share are measured using the ex ante or grant-date value of stock options and restricted stock. The model is specified in a manner that permits substitution across types of pay, relaxes restrictive assumptions about the time-series relations between compensation and performance, and accommodates reciprocal relations between pay and performance. Analysis of the estimation results indicates that both the cash bonus share and the stock-based share of total compensation vary positively with market and accounting returns. The results also support hypotheses that, in the determination of compensation awards, market performance is evaluated relative to industry performance, accounting performance is evaluated relative to previous firm and industry performance, cash bonuses and stock-based awards are substituted for each other, and a premium is paid to substitute stock-based pay for cash bonus pay. With respect to the time series relations between compensation and performance, the estimation results indicate that compensation changes associated with performance shocks are not permanent and that, for the purpose of determining executive bonuses and awards, the time series of accounti...

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

This paper extends the literature on executive compensation by developing and testing a principal-agent model in the context of project selection. The model’s focus on executive project selection decisions highlights the multidimensional nature of executive choices that affect the value of the firm. An executive not only makes an effort choice that determines the quality of information on which to base a decision but also sets the decision criteria for selecting projects. A project selection framework is also shown to introduce endogenous uncertainty into compensation that can influence the executive’s effort choice. Using an extensive data set, our empirical work supports the main hypotheses of the model, including the significance of executive rank in determining the extent of use of incentive pay in general and equitybased incentive pay in particular.

This study examines CEO compensation in family firms, with a particular focus on the effects exerted by governance characteristics such as ownership concentration, wedge between voting and cash-flow rights rights, and the presence of shareholder agreements. On a sample of Italian-listed companies over the period 1998-2002, we provide empirical evidence that family firms pay CEOs systematically more then other firms, and that the ownership structure exerts a significant effect on CEO compensation. In family firms, CEO pay is indeed positively affected by low ownership concentration, as well as a low wedge between voting and cash flow rights. Moreover, the presence of shareholders agreements has a moderating role on the level of CEO compensation. These effects are more pronounced in family than in non-family firms. The analysis of the relationship between excess compensation and future firm performance reveals that the higher compensation granted to the CEO by family firms is related to worse stock and accounting returns and could therefore be interpreted as a form of rent extraction. This result holds only for lower degrees of ownership concentration, higher wedge, and in absence of shareholder agreements, and supports the hypothesis that the prevalent agency conflict within Italian-listed family firms is between family owners and minority shareholders, instead of between shareholders and managers. The higher compensation granted to the CEO could be the premium for the loyalty of the CEO to the family and for allowing the family to extract private benefits of control.

In this paper, I explore the effect of different product-market strategies on CEO compensation in established pharmaceutical firms. Specifically, I examine how the mix of compensation vehicles (cash-based versus equity-based) and the association between compensation awards and firm performance measures differ for CEOs of firms that produce brand name pharmaceuticals versus CEOs of firms that produce generic pharmaceuticals. I find that generic producers use a larger proportion of cash-based compensation, consistent with monitoring and risk-sharing arguments. I also find that generic producers place a larger weight on accounting performance measures than do brand name producers when determining CEO compensation, while brand name producers place a larger weight on stock returns than do generic producers. These results are also consistent with my expectations. CEO Compensation in Established Pharmaceutical Firms