Employee Compensation Contracts and Firm Performance in Uncertain Environments Empirical Evidence for Adjusting Pay-Performance Sensitivity

Agency theory argues that pay-performance sensitivity should be negatively associated with risk. Yet, empirical studies have reported mixed findings on this relationship, which may be attributable to such confounding factors as different levels of delegation and monitoring costs. Extending prior research, we use data from the proprietary database of a major car dealership in Taiwan to examine the relationships among risk, employee compensation contract design, and firm performance. Results show that pay-performance sensitivity (incentive) for salespersons is negatively associated with risk (i.e., volatility of sales volume), which supports the prediction of agency theory. Importantly, findings indicate that branch managers who adjust salespersons' pay-performance sensitivity consistent with the suggestion of agency theory perform better than those who do not make prompt or sufficient adjustments