Outside Employment Opportunities and Tournament Incentives

We present robust evidence that firms enlarge the executive pay gap when executive mobility is constrained by the enhanced enforceability of non-compete agreements. We interpret this finding as evidence that firms increase tournament incentives to keep executives incentivized after the loss of valuable outside employment options. Consistent with this argument, we observe more significant increases in pay gaps for executives with greater ex ante mobility options and in years close to CEO-dismissal events in which tournament-incentive mechanisms are more prevalent. Following restrictions to executive mobility, equity portfolios that long (short) firms that (do not) boost the executive pay gap generate positive alphas. We rule out CEO power, managerial talent differentials, and CEO bargaining power as alternative explanations driving our results. Our findings suggest that there is a substitution effect between external (outside employment opportunities) and internal (pay gap) tournament incentives, hence provide novel evidence on a new executive pay gap determinant