Paying to Make a Difference: Executive Compensation and Product Dynamics
AbstractThis paper develops an agency model of executive compensation in dynamic industry equilibrium. Firms differ in the quality of their products, and managers can make a difference as higher effort brings about product improvement. I show that there is an inverse relationship between the magnitude of the performance-based component of optimal compensation contracts and the degree of product differentiation, as managerial effort is less likely to make a difference for firms with more differentiated products. Empirically, I find strong evidence of this inverse relation in the compensation of US executives. In particular, I find that pay-performance sensitivity depends negatively on industry- and firm-level measures of product differentiation, even after controlling for industry fixed effects and standard measures of product market competition. Moreover, industry leaders have weaker pay-performance sensitivity than laggards, even after controlling for firm size. My findings suggest that industry is an important determinant of executive compensation
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Bibliographic InfoPaper provided by Society for Economic Dynamics in its series 2006 Meeting Papers with number 690.
Date of creation: 03 Dec 2006
Date of revision:
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Postal: Society for Economic Dynamics Christian Zimmermann Economic Research Federal Reserve Bank of St. Louis PO Box 442 St. Louis MO 63166-0442 USA
Web page: http://www.EconomicDynamics.org/society.htm
More information through EDIRC
Incentives; Optimal Contracts; Executive Compensation; Industry Dynamics;
Find related papers by JEL classification:
- G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
- G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance
This paper has been announced in the following NEP Reports:
- NEP-ALL-2007-01-13 (All new papers)
- NEP-BEC-2007-01-13 (Business Economics)
- NEP-MIC-2007-01-13 (Microeconomics)
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