Executive Compensation and Incentive Pay Sensitivity Prior to CEO Turnover : Evidence from US Firms

In this study, we examine the three components of executive compensation including salary, equity, and bonus pay over a CEO’s tenure for US publicly-traded firms. We confirm a positive and significant relationship between two separate measures of firm performance and incentive pay. We also identify significant differences between equity and bonus incentive compensation. We find that variables indicative of an increase in the likelihood of anticipated CEO turnover are associated with greater sensitivity of bonus compensation to changes in firm performance. Specifically, this pay-performance link is enhanced for CEOs who reach retirement age. Further, the sensitivity of bonus pay to firm performance is significantly greater when there is planned CEO turnover within a two-year window. We find no similar changes in pay-performance sensitivity for equity-based compensation or salary. These findings suggest that when a CEO’s departure is anticipated, firms increase bonus pay incentives for a CEO’s effort based on the firm’s concurrent performance to compensate for the reduction in the incentives that rely on the executive being employed long-term. The results provide a rationale for including bonus pay in the overall executive compensation package