The Journal of Finance Forthcoming Article Abstract

View Full Article in

Abstract:
We argue that powerful CEOs induce their boards to shift the weight on performance measures towards the better performing measures, thereby “rigging” the incentive part of their pay. The intuition is developed in a simple model in which some powerful CEOs exploit superior information and lack of transparency in compensation contracts to extract rents. The model delivers an explicit form for the rigging of CEO incentive pay along with testable implications that rigging is expected to (1) increase with CEO power; (2) increase with CEO human capital intensity and uncertainty about a firm's future prospects; and (3) negatively impact firm performance. Using measures of CEO power and board independence on a large panel of firms in the U.S., we find support for these predictions. Our results provide evidence supporting the entrenchment skimming theory and advocate for requiring ex ante disclosure of incentive contract terms.