The effect of ratcheting performance standards on CEO compensation
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I examine the effect of ratcheting performance standards on the pay-performance sensitivity of CEOs over the period 1992 ï¿½ 1999. Indjejikian and Nanda (1999) in an analytical study, derive one empirically testable theoretical prediction. They predict that in order to counter the agentï¿½s propensity to reduce effort (and output) in early periods to avoid being held to a higher standard in the future, the principal sets pay-performance sensitivities high in the presence of the ratchet effect. Thus, ex-post, one would expect to observe higher pay-performance sensitivities for ratchet firms than for non-ratchet firms. |I test Indjejikian and Nandaï¿½s (1999) theoretical prediction using simultaneous equations for a sample of 320 ratchet firm-years and 218 non-ratchet firm-years over the period 1992-1999. Results (3SLS estimation) indicate that there is no significant difference in ROA pay-performance sensitivity between ratchet firms and non-ratchet firms. However, the RET pay-performance sensitivity is indeed higher (as predicted) for ratchet firms than for non-ratchet firms. I interpret the results of the 3SLS estimation as providing mixed support for the Indjejikian and Nanda (1999) model.