CEO prior uncertainty and pay–performance sensitivity

Abstract

A CEO's pay–performance sensitivity (PPS) is higher in the first year of their tenure than in the following years. I explain this finding with reference to chief executive officer (CEO) prior uncertainty: Because of information asymmetry and/or uncertainty about the quality of the match between a CEO and a firm, first‐year compensation is often arranged to depend largely on performance. Consistent with this explanation, CEOs with higher prior uncertainty exhibit higher first‐year PPS. Also, PPS is higher for outsider CEOs than insider CEOs. Among outsider CEOs, first‐year PPS is lower for former executives of large public firms. An insider CEO's service time in a firm before becoming the CEO reduces first‐year PPS.