AUTHORITY, RISK, AND PERFORMANCE INCENTIVES: EVIDENCE FROM DIVISION MANAGER POSITIONS INSIDE FIRMS

Authors


  • *I would like to especially thank Charles Himmelberg, Raghuram Rajan, Scott Stern, and Eric Van den Steen for helpful comments and Katie Donohue at Hewitt Associates for assistance with data collection. I also would like to thank Rajesh Aggarwal, Ben Campbell, Francine Lafontaine, Vinay Nair, Paul Oyer, Canice Prendergast, Tano Santos, Justin Wolfers, Jan Zabojnik, the editor and two anonymous referees, and seminar participants at Northwestern University (Kellogg), Washington University (Olin) and the Applied Econ Summer Workshop at Wharton. I acknowledge research support from the Center for Leadership at the Wharton School.

Abstract

I show that performance incentives vary by decision-making authority of division managers. For division managers with broader authority, i.e., those designated as corporate officers, both the sensitivity of pay to global performance measures and the relative importance of global to local measures are larger, relative to non-officers. There is no difference in sensitivity of pay to local measures by officer status. These results support theories suggesting that authority over project selection combined with incentives designed to maximize firm performance, as well as induce effort for the division, are important in incentive design for division managers. Consistent with earlier findings, the evidence strongly supports one of the main predictions of the principal-agent model, that is, a negative tradeoff between risk and incentives.

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