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Contests to Become CEO: Incentives, Selection and Handicaps

  • Theofanis Tsoulouhas

    ()

    (Department of Economics, North Carolina State University)

  • Charles R. Knoeber

    ()

    (Department of Economics, North Carolina State University)

  • Anup Agrawal

    ()

    (Cluverhouse College of Business, University of Alabama)

Should a firm favor insiders (handicap outsiders) when selecting a CEO? One reason to do so is to take advantage of the contest to become CEO as a device for providing current incentives to employees. An important reason not to do so is that this can reduce the ability of future CEOs and, hence, future profits. The trade-off between providing current incentives and selecting the most able individual to become CEO is the focus of this paper. If insiders are good enough (better or nearly as good as outsiders), it is typically optimal to handicap outsiders, sometimes so severely that they have no chance to win the contest. However, if outsiders are sufficiently better than insiders, selection dominates and it is the insiders who are severely handicapped. Our model provides useful insight into contests to become CEO and rationalizes empirical regularities in the source of CEOs chosen by firms.

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Paper provided by North Carolina State University, Department of Economics in its series Working Paper Series with number 002.

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Length: 34 pages
Date of creation:
Date of revision: Jul 2004
Handle: RePEc:ncs:wpaper:002
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Web page: http://www.mgt.ncsu.edu/faculty/economics.html

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  1. Chan, William, 1996. "External Recruitment versus Internal Promotion," Journal of Labor Economics, University of Chicago Press, vol. 14(4), pages 555-70, October.
  2. Joao Ricardo Faria, 2000. "An Economic Analysis of the Peter and Dilbert Principles," Working Paper Series 101, Finance Discipline Group, UTS Business School, University of Technology, Sydney.
  3. Sherwin Rosen, 1985. "Prizes and Incentives in Elimination Tournaments," NBER Working Papers 1668, National Bureau of Economic Research, Inc.
  4. Edward P. Lazear, 2004. "The Peter Principle: A Theory of Decline," Journal of Political Economy, University of Chicago Press, vol. 112(S1), pages S141-S163, February.
  5. Rajesh K. Aggarwal & Andrew A. Samwick, 2003. "Performance Incentives within Firms: The Effect of Managerial Responsibility," Journal of Finance, American Finance Association, vol. 58(4), pages 1613-1650, 08.
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