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Implicit Contracts and the Explanatory Power of Top Executive Compensation for Future Performance

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  • Rachel M. Hayes
  • Scott Schaefer
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    Abstract

    Recent research suggests that implicit incentive contracts may be based on performance measures that are observable only to the contracting parties. We derive and test implications of this insight for the relationship between executive compensation and firm performance. If corporate boards optimally use both observable and unobservable (to outsiders) measures of executive performance and the unobservable measures are correlated with future firm performance, then unexplained variation in current compensation should predict future variation in firm performance. Further, compensation should be more positively associated with future performance when observable measures are less useful for contracting. Our results are consistent with these hypotheses.

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    Bibliographic Info

    Article provided by The RAND Corporation in its journal RAND Journal of Economics.

    Volume (Year): 31 (2000)
    Issue (Month): 2 (Summer)
    Pages: 273-293

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    Handle: RePEc:rje:randje:v:31:y:2000:i:summer:p:273-293

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    Cited by:
    1. Bushman, Robert & Chen, Qi & Engel, Ellen & Smith, Abbie, 2004. "Financial accounting information, organizational complexity and corporate governance systems," Journal of Accounting and Economics, Elsevier, Elsevier, vol. 37(2), pages 167-201, June.
    2. Hillegeist, Stephen A. & Peñalva, Fernando, 2004. "Stock option incentives and firm performance," IESE Research Papers, IESE Business School D/535, IESE Business School.
    3. Hongfei Tang, 2014. "Are CEO stock option grants optimal? Evidence from family firms and non-family firms around the Sarbanes–Oxley Act," Review of Quantitative Finance and Accounting, Springer, Springer, vol. 42(2), pages 251-292, February.
    4. Edward P. Lazear, 1995. "Personnel Economics," MIT Press Books, The MIT Press, The MIT Press, edition 1, volume 1, number 0262121883, December.
    5. Renneboog, L.D.R. & Trojanowski, G., 2002. "The Managerial Labor Market and the Governance Role of Shareholder Control Structures in the UK," Discussion Paper, Tilburg University, Center for Economic Research 2002-68, Tilburg University, Center for Economic Research.
    6. Dominique Demougin & Oliver Fabel & Christian Thomann, 2009. "Implicit vs. Explicit Incentives: Theory and a Case Study," CESifo Working Paper Series, CESifo Group Munich 2645, CESifo Group Munich.
    7. Sabac, Florin, 2008. "Dynamic incentives and retirement," Journal of Accounting and Economics, Elsevier, Elsevier, vol. 46(1), pages 172-200, September.
    8. Oyer, Paul & Schaefer, Scott, 2011. "Personnel Economics: Hiring and Incentives," Handbook of Labor Economics, Elsevier, Elsevier.
    9. Bouwens, J.F.M.G. & Lent, L.A.G.M. van, 2006. "Assessing the Performance of Business Unit Managers," Discussion Paper, Tilburg University, Center for Economic Research 2006-92, Tilburg University, Center for Economic Research.
    10. Shingo Takahashi & Hideo Owan & Tsuyoshi Tsuru & Katsuhito Uehara, 2014. "Perceptions to climatic changes and cooperative attitudes toward flood protection in Bangladesh," Working Papers, Research Institute, International University of Japan EMS_2014_11, Research Institute, International University of Japan.
    11. Jan Zabojnik, 2011. "Subjective Evaluations with Performance Feedback," Working Papers, Queen's University, Department of Economics 1283, Queen's University, Department of Economics.
    12. Davila, Antonio, 2003. "Short-term economic incentives in new product development," Research Policy, Elsevier, Elsevier, vol. 32(8), pages 1397-1420, September.
    13. Arantxa Jarque, 2008. "CEO compensation : trends, market changes, and regulation," Economic Quarterly, Federal Reserve Bank of Richmond, Federal Reserve Bank of Richmond, issue Sum, pages 265-300.
    14. Golman, Russell & Bhatia, Sudeep, 2012. "Performance evaluation inflation and compression," Accounting, Organizations and Society, Elsevier, vol. 37(8), pages 534-543.
    15. Bushman, Robert M. & Smith, Abbie J., 2001. "Financial accounting information and corporate governance," Journal of Accounting and Economics, Elsevier, Elsevier, vol. 32(1-3), pages 237-333, December.
    16. Otten, J.A., 2008. "Theories on executive pay. A literature overview and critical assessment," MPRA Paper 6969, University Library of Munich, Germany.
    17. Moers, Frank, 2005. "Discretion and bias in performance evaluation: the impact of diversity and subjectivity," Accounting, Organizations and Society, Elsevier, vol. 30(1), pages 67-80, January.

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