AAA Spark Meeting of Regions

Tournament Incentives and Corporate Overinvestment

• In Event: Emerging Economy Incentives

Abstract

Prior studies suggest that promotion-based tournament incentives can enhance management risk-taking and result in greater managerial propensity to commit financial reporting misconduct. In this study, we empirically investigate the relation between tournament incentives and corporate investment efficiency to determine whether the pay-gap-created incentives can lead to firms’ propensity to overinvest. Using a sample of US firms from 1992-2016, we find that tournament incentives are significantly associated with an increased level of corporate overinvestments. Our results are robust to controlling for firm fixed effects and two-stage instrumental variable analyses. Overall, we support that promotion-based tournaments can provide incentives to top executives to increase firm operating risk by adopting riskier investment policies. By documenting the real business impact of CEO promotion tournament on corporate overinvestment, our findings expand our perception on the relation between management compensation schemes and corporate investment policies.

Authors

• Yin Liu, SUNY Brockport

• Khondkar E Karim, University of Massachusetts-Lowell

• Heeick Choi, UMass Lowell