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Market-Based Solutions to Vital Economic Issues


Kenan Institute 2024 Grand Challenge: Business Resilience
Market-Based Solutions to Vital Economic Issues
Jan 1, 2016

Management Team Incentive Dispersion and Firm Performance


Recent theory suggests that firms incorporate synergistic interrelationships among executives into optimal incentive design (Edmans et al. 2013). We focus on Pay Performance Sensitivities (PPS) and use dispersion in PPS across top executives as a proxy for the incentive design component shaped by an executive team’s synergy profile. We model optimal PPS dispersion and use residuals from this model to measure deviations from optimal. We find that firm performance is increasing (decreasing) in the residual when PPS dispersion is too low (too high). We conjecture that deviations from optimal are sustained by adjustment costs, finding that firms only close around 60% of the gap between target and actual PPS dispersion over the subsequent year. Viewing a team’s equity grants as a vector, we provide evidence that firms use subsequent equity grants to actively manage PPS dispersion towards optimality. Cross-sectional analysis reveals that the deleterious effect of deviations from optimal is decreasing in the duration of a team’s tenure together, and increasing in the importance of effort coordination across team members for firm performance.

Note: Research papers posted on SSRN, including any findings, may differ from the final version chosen for publication in academic journals.

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