Implicit Contracts and the Explanatory Power of Top Executive Compensation for Future Performance

Recent research suggests that implicit incentive contracts may be based on performance measures that are observable only to the contracting parties. We derive and test implications of this insight for the relationship between executive compensation and firm performance. If corporate boards optimally...

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Bibliographic Details
Published inThe Rand journal of economics Vol. 31; no. 2; pp. 273 - 293
Main Authors Hayes, Rachel M., Schaefer, Scott
Format Journal Article
LanguageEnglish
Published Santa Monica Rand 01.07.2000
The RAND Corporation
Rand Corporation
SeriesRAND Journal of Economics
Subjects
Agency theory
Analytical forecasting
Business structures
Chief executive officers
Compensation
Contract incentives
Contracts
Earnings
Earnings forecasting
Economic incentives
Economic models
Executive compensation
Executives
Hypotheses
Incentives
Income
Observational research
Pay for performance
Performance metrics
Statistical analysis
Unobservables
Variable coefficients
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Summary:Recent research suggests that implicit incentive contracts may be based on performance measures that are observable only to the contracting parties. We derive and test implications of this insight for the relationship between executive compensation and firm performance. If corporate boards optimally use both observable and unobservable (to outsiders) measures of executive performance and the unobservable measures are correlated with future firm performance, then unexplained variation in current compensation should predict future variation in firm performance. Further, compensation should be more positively associated with future performance when observable measures are less useful for contracting. Our results are consistent with these hypotheses.
Bibliography:ObjectType-Article-2
SourceType-Scholarly Journals-1
ObjectType-Feature-1
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ISSN:0741-6261
1756-2171
DOI:10.2307/2601041