The Role of Executive Cash Bonuses in Providing Individual and Team Incentives

Abstract

Given the substantial stock and option portfolios held by most CEOs, much recent literature on CEO incentives regards cash-based bonus plans as largely irrelevant. This begs the question of why nearly all CEO compensation plans include such bonuses. We re-examine the incentives provided by bonuses and their role in executive compensation packages. Using detailed data on bonus plans, we document that the pay-performance sensitivity of CEO cash compensation is much greater than prior estimates and that cash-based pay provides a substantial portion of many CEOs’ total financial incentives early in their tenure. However, we find little evidence that boards adjust bonus plans over time in response to CEO-specific equity holdings. This “stickiness” results in growing disparity between the magnitudes of cash- and equity portfolio-based incentives over a typical CEO’s tenure and suggests that cash-based bonuses may be designed for purposes beyond providing individual incentives. Consistent with this conjecture, we find evidence that bonus plans are used to encourage mutual monitoring and to facilitate coordination across the top management team. We conclude that the incentives provided by CEO cash-based bonuses should be considered within the context of team incentives for top management as a whole.

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