R&D Intensity, Ability Indicators, and Executive Compensation

We examine the relation between R&D intensity and the weights on ability indicators and financial performance measures in CEO compensation. The CEO’s technology-related ability is likely more important in R&D intensive firms. Therefore, we predict that these firms place higher weights on indicators of technology-related ability, using the compensation contract as a screening device to mitigate the adverse selection problem. Both accounting and market performance measures are likely noisier in R&D intensive firms. Therefore, we predict that these firms rely less on short-term incentives tied to concurrent earnings and stock returns and rely more on long-term equity incentives. We test these predictions using hand-collected data on the education and professional background of the CEOs in Execucomp during 1992-2006. The results support our predictions and are robust. While prior research examined performance compensation in the context of moral hazard, our findings suggest that compensation based on ability indicators plays a screening role in the context of adverse selection