Management Team Incentive Misalignment and Firm Value

• In Event: Executive Compensation I

Abstract

This paper investigates associations between top management team incentive alignment and firm
value/performance. We conceptualize team incentive alignment as arising from the intricate
structure of relations across executives’ individual pay packages. Our central focus is on
dispersion in pay performance sensitivities (PPS) across top executives. While existing theory
demonstrates that variation in PPS across team members can be optimal, we find that PPS
dispersion is negatively associated with firm value as measured by Tobin’s Q and with operating
performance (ROA). Further, we find that PPS dispersion significantly weakens the positive
effects of both tournament incentives and average team PPS, and significantly exacerbates the
negative performance implications associated with CEO pay slice. We conjecture that PPS
dispersion promotes free-riding behavior that interferes with executives’ incentives to cooperate.
Consistent with this conjecture, we find that the negative effects of PPS dispersion are weakened
as the duration of the team’s tenure increases but become more severe as firm complexity
increases, suggesting that improved (or better) cooperation within the management team over
time (or cross firms) offsets the deleterious effects of PPS dispersion.

Authors

• Robert M Bushman, The University of North Carolina at Chapel Hill

• Zhonglan Dai, The University of Texas at Dallas

• Weining Zhang, Cheung Kong Graduate School of Business