Abstract:

A higher incentive is associated with better firm performance. We introduce a model of CEO-firm matching to disentangle the two confounding effects that drive this result: on the one hand, the direct incentive effect induces higher effort; on the other hand, the indirect selection effect that more talented CEOs are matched to firms providing higher incentives. I find both effects are important to explain the result; with selection effect accounting for 16% of the total effect.