Two Essays on Industry Tournament Incentives

A large body of literature has developed on the disparities in compensation among chief executive officers. Financial media has highlighted the fact that CEOs in the United States receive excessive pay and that the gap among executive compensation is soaring. High compensation creates incentives for CEOs to take higher risk in firm policies to land a more attractive position managing another firm and attaining higher pay which is considered the ultimate prize (Kale, Reis, and Venkateswaran 2009; Coles, Daniel, and Naveen 2006). This creates a tournament in the managerial labor market. We define this tournament as the pay differential between one firm’s CEO and the maximal industry CEO compensation in the same industry. In the first essay, we evaluate the link between industry tournament incentives and investment inefficiency. We find that firms with higher tournament incentives exhibit higher investment inefficiency. Additionally, cross-sectional tests suggest that these effects operate at least in part through both a financing channel and a monitoring channel. Taken together, our results suggest that industry tournament incentives place pressure on CEOs and affect the efficiency of firm investments. In the second essay, we empirically assess industry tournament incentives for CEOs, as measured by the compensation gap between a CEO at one firm and the maximal pay of the CEO in the same industry. We find that speed of adjustment for capital and R&D investments are positively associated with the external industry pay gap. Additionally, industry tournament effects are stronger for small-size and high-growth firms. Furthermore, we find that industry tournament-induced incentives are associated with lower firm value. Overall, this dissertation contributes to prior literature by showing that industry tournament incentives are essential to firm investment policy, suggesting it is vital for policymakers to take into consideration tournament incentives when implementing firm policies