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Performance-Based Compensation and Firm Value: Experimental evidence

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  • Glenn Pfeiffer

    ()
    (Argyros School of Business and Economics, Chapman University, USA)

  • Timothy Shields

    (Argyros School of Business and Economics, Chapman University, USA)

Abstract

Motivated by research reporting positive price reactions to adoption of performance-based compensation plans, we examine price reactions to compensation contracting in experimental markets. The design allows us to manipulate variables separately and study issues of adverse selection (sorting) and moral hazard (incentives). We find that managers select contracts based on their private information, and that information is conveyed to the market by the choice of compensation contract and reflected in price. Additionally, we find that managers do not always exert costly effort in spite of favorable incentives to do so (shirking). As a result, the market is skeptical of incentive benefits. Thus, while we find evidence of overbidding in some treatments, we find that market prices are consistent with private information revelation but undervalue incentive benefits.

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Bibliographic Info

Paper provided by Chapman University, Economic Science Institute in its series Working Papers with number 12-17.

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Length: 53 pages
Date of creation: 2012
Date of revision:
Handle: RePEc:chu:wpaper:12-17

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Keywords: compensation; experimental markets; sorting; incentives;

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  1. Brickley, James A. & Bhagat, Sanjai & Lease, Ronald C., 1985. "The impact of long-range managerial compensation plans on shareholder wealth," Journal of Accounting and Economics, Elsevier, vol. 7(1-3), pages 115-129, April.
  2. Scholes, Myron S, 1991. " Stock and Compensation," Journal of Finance, American Finance Association, vol. 46(3), pages 803-23, July.
  3. Oyer, Paul & Schaefer, Scott, 2005. "Why do some firms give stock options to all employees?: An empirical examination of alternative theories," Journal of Financial Economics, Elsevier, vol. 76(1), pages 99-133, April.
  4. Tehranian, Hassan & Waegelein, James F., 1985. "Market reaction to short-term executive compensation plan adoption," Journal of Accounting and Economics, Elsevier, vol. 7(1-3), pages 131-144, April.
  5. Warner, Jerold B., 1985. "Stock market reaction to management incentive plan adoption : An overview," Journal of Accounting and Economics, Elsevier, vol. 7(1-3), pages 145-149, April.
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