CEO incentive dynamics and their effect on firm value

This paper examines the trajectory of pay-performance-sensitivity (PPS) in the years immediately after chief executive officers (CEOs) assume their positions. We show that PPS “steady state equilibrium” is not achieved overnight, but instead evolves through a process whereby CEO incentives increase gradually before eventually leveling off. We discuss various factors that might contribute to these observed dynamics including liquidity constraints, career concerns, entrenchment, survivor bias, and learning of the CEOs’ true abilities. We find strong support for some, but only mixed support for others. Because median CEO tenure in ExecuComp is eight years, our results suggest that this dynamics of incentive accumulations over a CEO’s tenure cannot be ignored when studying executive incentive schemes. Finally, we show this gradual adjustment of PPS over a CEO’s tenure to have a meaningful impact on firm valuation, as measured by Tobin’s Q.