Rank-Order Tournaments and Incentive Alignment: The Effect on Firm Performance

Authors

  • JAYANT R. KALE,

  • EBRU REIS,

  • ANAND VENKATESWARAN

    Search for more papers by this author
    • Jayant R. Kale is with J. Mack Robinson College of Business, Georgia State University. Ebru Reis is with Bentley University. Reis was with Farmer School of Business, Miami University when work on this paper was carried out. Anand Venkateswaran is with College of Business, Northeastern University. Kale's research was supported, in part, by a grant from the Research Program Council of the J. Mack Robinson College of Business at Georgia State University, and the H. Talmage Dobbs, Jr. Chair of Finance. We have benefited from the comments of Christopher Baum, Paul Bolster, Bunmi Faleye, Gerry Gay, Marty Grace, Jason Greene, Alexander Kempf, Omesh Kini, Kai Li, Reza Mahani, Greg Nagel, Alexandra Niessen, Chip Ryan, Mark Schaffer, Husayn Shahrur, Milind Shrikhande, Ajay Subramanian, Steve Wyatt, and Rajesh Aggarwal, the discussant at the Centre for Analytical Finance Summer Conference at the Indian School of Business, Hyderabad (2007). We appreciate the feedback from seminar participants at Bentley College, Georgia State University, Financial Management Association Meeting (2006), Indian Institute of Management—Bangalore, Indian School of Business—Hyderabad, Miami University, Northeastern University, and the University of Cologne. We thank Campbell Harvey (the editor), an associate editor, and the referee for providing many valuable suggestions that significantly improved the paper. We especially thank Jeffrey Wooldridge for help in clarifying some econometric issues. We are responsible for all errors.


ABSTRACT

We investigate simultaneously the impact of promotion-based tournament incentives for VPs and equity-based (alignment) incentives for VPs and the chief executive officer (CEO) on firm performance. We find that tournament incentives, as measured by the pay differential between the CEO and VPs, relate positively to firm performance. The relation is more positive when the CEO nears retirement and less positive when the firm has a new CEO, and weakens further when the new CEO is an outsider. Our analysis is robust to corrections for endogeneity of all our incentive measures and to several alternative measures of tournament incentives and firm performance.

Ancillary