A Corporate Governance Reform as a Natural Experiment for Incentive Contracts

We use a major shift in the legal and institutional environment to identify contractual incentives from the correlation of executive pay and performance. We take the reform of the German stock companies act in 1884 as such a major shift, and estimate the sensitivity of pay to performance between 1870 and 1910 for executives of nine large banks. The reform substantially enhanced corporate control and strengthened monitoring incentives. Accordingly, we find the pay-performance sensitivity decreases significantly after the reform. Executives received a bonus of M29 per M1,000, increasing profits before 1884, but after the reform the sensitivity decreased by two-thirds