In our paper Are Incentive Contracts Rigged By Powerful CEOs?, which is forthcoming in the Journal of Finance, we argue that powerful CEOs induce their boards to shift the weight on performance measures towards the better performing measures, thereby rigging the incentive part of their pay. The intuition is developed in a simple model in which some powerful CEOs exploit superior information and lack of transparency in compensation contracts to extract rents. The model delivers an explicit form for the rigging of CEO incentive pay along with testable implications that rigging is expected to (1) increase with CEO power; (2) increase with CEO human capital intensity and uncertainty about a firm’s future prospects; and (3) negatively impact firm performance.

Using a large panel of U.S. firms from 1992-2003, we find support for all our predictions. We find that rigging explains 10% to 30% of the incentive pay sensitivity to performance. Rigging increases with CEO human capital and with the uncertainty of a firm’s prospects, and stronger governance along other dimensions moderates contract rigging by powerful CEOs. Finally, rigging of incentive pay is shown to be associated with a decrease in future firm performance and value.

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