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Performance Standards, CEO Compensation and Pay Sensitivity Estimates
Sheen Liu,
Washington State University
Peter D. Woodlock, Youngstown State University
ABSTRACT. This paper explores how changes in performance standards affect compensation contracts and ordinary least squares (OLS) measures of pay sensitivity derived from such contracts. We find that optimal compensation contracts with higher performance standards are more top-heavy at the upper and lower ends of firm performance when compared with optimal compensation contracts with lower performance standards. Because of this effect, OLS measures of pay sensitivity can either increase or decrease as changes in performance standards occur. These changes in OLS measures can occur even though the contracts with the higher or lower performance standards provide the CEO with similar incentives.
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