Rank Order Tournaments and Incentive Alignment: The Effect on Firm Performance
62 Pages Posted: 25 Feb 2008
Date Written: November 2007
In this article, we study the effectiveness of promotion-based tournament incentives. We simultaneously investigate tournament incentives for the VP and performance- or equity- based (alignment) incentives for the VP and the CEO. We find that tournament incentives, as measured by the pay differential between the CEO and VPs, relate positively to firm performance. We show that the effect of tournament incentives on firm performance is weaker when the firm has a new CEO and more so when the new CEO is an outsider, and when the firm belongs to a homogeneous industry. On the other hand, tournament effects are stronger when the CEO is close to retirement. Our analysis is robust to corrections for endogeneity of all our incentive measures as well for several alternate measures of tournament incentives and firm performance.
Keywords: Managerial incentives, Tournaments, Executive compensation, Firm performance
JEL Classification: G34, G35, J33, L14, L35
Suggested Citation: Suggested Citation