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Growth Options, Incentives, and Pay for Performance: Theory and Evidence

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  • Sebastian Gryglewicz

    (Erasmus School of Economics, Erasmus University Rotterdam, Rotterdam 3000DR, Netherlands)

  • Barney Hartman-Glaser

    (Anderson School of Management, University of California, Los Angeles, Los Angeles, California 90095-1481)

  • Geoffery Zheng

    (Anderson School of Management, University of California, Los Angeles, Los Angeles, California 90095-1481)

Abstract

Pay–performance sensitivity is a common proxy for the strength of incentives. We show that growth options create a wedge between expected-pay–effort sensitivity, which determines actual incentives, and pay–performance sensitivity, which is the ratio of expected-pay–effort to performance–effort sensitivity. An increase in growth option intensity can increase performance–effort sensitivity more than expected-pay–effort sensitivity so that, as incentives increase, pay–performance sensitivity decreases. We document empirical evidence consistent with this finding. Pay–performance sensitivity, measured by dollar changes in manager wealth over dollar changes in firm value, decreases with proxies for growth option intensity and increases with proxies for growth option exercise.

Suggested Citation

  • Sebastian Gryglewicz & Barney Hartman-Glaser & Geoffery Zheng, 2020. "Growth Options, Incentives, and Pay for Performance: Theory and Evidence," Management Science, INFORMS, vol. 66(3), pages 1248-1277, March.
    • Handle: RePEc:inm:ormnsc:v:66:y:2020:i:3:p:1248-1277
    DOI: 10.1287/mnsc.2018.3267
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    Cited by:

    1. Alain Bensoussan & Benoit Chevalier-Roignant & Alejandro Rivera, 2021. "Does Performance-Sensitive Debt mitigate Debt Overhang?," Post-Print hal-03364891, HAL.
    2. Morellec, Erwan & Gryglewicz, Sebastian & Mayer, Simon, 2018. "Agency Conflicts over the Short and Long Run: Short-termism, Long-termism, and Pay-for-Luck," CEPR Discussion Papers 12720, C.E.P.R. Discussion Papers.
    3. Emma Hubert, 2023. "Continuous-time incentives in hierarchies," Finance and Stochastics, Springer, vol. 27(3), pages 605-661, July.
    4. Emma Hubert, 2020. "Continuous-time incentives in hierarchies," Papers 2007.10758, arXiv.org.
    5. Bensoussan, Alain & Chevalier-Roignant, Benoît & Rivera, Alejandro, 2021. "Does performance-sensitive debt mitigate debt overhang?," Journal of Economic Dynamics and Control, Elsevier, vol. 131(C).

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