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Aligning Incentives by Capping Bonuses

In: Essays in Accounting Theory in Honour of Joel S. Demski

Author

Listed:
  • Anil Arya

    (Ohio State University)

  • Jonathan Glover

    (Carnegie Mellon University)

  • Brian Mittendorf

    (Yale School of Management)

Abstract

A puzzling feature of many incentive compensation plans is the practice of capping bonuses above a certain threshold. While bonus caps are often justified on the grounds of keeping pay levels in check, it has also been argued that such caps can wreak havoc on a firm’s incentive problems. In this paper, we study a setting in which bonus caps can actually help align incentives. When a CEO is impatient, she may be tempted to take a hardline stance with a privately-informed manager in project selection: if she places little weight on future flows, she is fixated on cost-cutting and curtailing budget padding. A bonus cap can soften the CEO’s posture by inducing risk aversion and thus creating a preference for a middle ground. We show that this force can enable a judiciously chosen cap to achieve goal congruence between shareholders and a CEO.

Suggested Citation

  • Anil Arya & Jonathan Glover & Brian Mittendorf, 2007. "Aligning Incentives by Capping Bonuses," Springer Books, in: Rick Antle & Frøystein Gjesdal & Pierre Jinghong Liang (ed.), Essays in Accounting Theory in Honour of Joel S. Demski, chapter 0, pages 169-182, Springer.
    • Handle: RePEc:spr:sprchp:978-0-387-30399-4_8
    DOI: 10.1007/978-0-387-30399-4_8
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    Citations

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    Cited by:

    1. Daniel Herold, 2017. "The Impact of Incentive Pay on Corporate Crime," MAGKS Papers on Economics 201752, Philipps-Universität Marburg, Faculty of Business Administration and Economics, Department of Economics (Volkswirtschaftliche Abteilung).
    2. Mark S. Carey & Bo Sun, 2015. "Risk Choices and Compensation Design," International Finance Discussion Papers 1130, Board of Governors of the Federal Reserve System (U.S.).
    3. Detzen, Dominic & Zülch, Henning, 2012. "Executive compensation and goodwill recognition under IFRS: Evidence from European mergers," Journal of International Accounting, Auditing and Taxation, Elsevier, vol. 21(2), pages 106-126.
    4. Eric S. Chou & Chien-Lung Chen, 2015. "Can Agents Be Better Off with Pay Caps?," Scandinavian Journal of Economics, Wiley Blackwell, vol. 117(4), pages 1069-1090, October.

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