Pay-performance sensitivity is a common proxy for the strength of incentives. We show that growth options create a wedge between expected-pay-effort sensitivity, which determines actual incentives, and pay-performance sensitivity, which is the ratio of expected-pay-effort to performance-effort sensitivity. An increase in growth option intensity can increase performance-effort sensitivity more than expected-pay-effort sensitivity so that as incentives increase, pay-performance sensitivity decreases. We document empirical evidence consistent with this finding. Pay-performance sensitivity, measured by dollar changes in manager wealth over dollar changes in firm value, decreases with proxies for growth option intensity and increases with proxies for growth option exercise.

Dynamic Contracting, Real Options, Pay-Performance Sensitivity.
Economics of Contract Law (jel D86), Intertemporal Firm Choice and Growth, Investment, or Financing (jel D92), Capital Budgeting; Investment Policy (jel G31), Financing Policy; Capital and Ownership Structure (jel G32), Personnel Management (jel M12)
hdl.handle.net/1765/116405
Management Science
Department of Business Economics

Gryglewicz, S, Hartman-Glaser, B., & Zheng, G. (2017). Growth Options, Incentives, and Pay-for-Performance: Theory and Evidence. Management Science, Accepted. Retrieved from http://hdl.handle.net/1765/116405