Placing their bets: The influence of strategic investment on CEO pay‐for‐performance

• Author: Wei Shi,Brian L. Connelly,Abhinav Gupta,Jeremy D. Mackey
• DOI: http://doi.org/10.1002/smj.3050
• Published date: 01 December 2019
• Date: 01 December 2019

RESEARCH ARTICLE

Placing their bets: The influence of strategic

investment on CEO pay-for-performance

Wei Shi

1

| Brian L. Connelly

2

| Jeremy D. Mackey

2

|

Abhinav Gupta

3

1

Miami Business School, University of

Miami, Coral Gables, Florida

2

Harbert College of Business, Auburn

University, Auburn, Alabama

3

Foster School of Business, University of

Washington, Seattle, Washington

Correspondence

Wei Shi, Miami Business School,

University of Miami, 5250 University Dr,

414J Jenkins Bldg, Coral Gables, FL 33146.

Email: wshi@bus.miami.edu

Abstract

Research Summary:A number of studies examine the

extent to which boards compensate CEOs for their firm's

performance (i.e., pay-for-performance), but these studies

typically do not incorporate what CEOs actually do to

bring about those performance outcomes. We suggest that

directors will make stronger internal attributions about

firm performance when the CEO engages in high levels of

corporate strategic investment. CEOs that invest in firm

growth essentially “place their bets,”so the pay-for-

performance relationship is stronger for them than it is for

CEOs who do not invest as much in firm growth. We also

theorize and find that directors make internal attributions

about firm performance more for prestigious, but not less

prestigious, CEOs and more when the directors collec-

tively exhibit conservative, but not liberal, political

ideologies.

Managerial Summary:Shareholders and other stake-

holders often demand that CEOs should be paid for perfor-

mance. In other words, CEOs should be paid well when the

company is performing well and paid less when the com-

pany is not performing well. We add an additional dimen-

sion: boards might also consider what CEOs actually do to

bring about performance outcomes. Our findings suggest

that when CEOs make heavy corporate investments, they

essentially “place their bets.”In this scenario, boards attri-

bute performance to the CEO so that CEO compensation

rises and falls with company performance. When CEOs

Received: 13 July 2017 Revised: 24 April 2019 Accepted: 26 April 2019 Published on: 20 June 2019

DOI: 10.1002/smj.3050

Strat Mgmt J. 2019;40:2047–2077. wileyonlinelibrary.com/journal/smj © 2019 John Wiley & Sons, Ltd. 2047

make fewer corporate investments, their compensation is

not as strongly associated with company performance. This

primary relationship is particularly true when CEOs have

high social recognition or when the directors are collec-

tively conservative.

KEYWORDS

attribution theory, boards of directors, CEO compensation, political

ideology, strategic risk-taking

1|INTRODUCTION

One of the most important functions of a board of directors is setting the CEO's compensation

(Devers, Cannella, Reilly, & Yoder, 2007). To do this, directors take many factors into account. For

example, they consider the size of the firm and industry in which it operates (Wade, O'Reilly, & Pol-

lock, 2006). They also account for the CEO's tenure at the firm and assess stakeholders' opinions

about the CEO's ability (Chen, Schenker, Frosto, & Henderson, 2004). Perhaps most importantly,

boards look at the company's stock market performance when making executive compensation deci-

sions, which is consistent with their fiduciary role to serve as representatives of the firm's share-

holders (Finkelstein, Hambrick, & Cannella, 2009; Walsh & Seward, 1990).

Embedded into agency theory is a pay-for-performance perspective that envisions CEO compen-

sation as an ex post means of settling up (Fama, 1980). This view puts forward the notion that the

job of the board is to make compensation decisions that reward the CEO for improving shareholder

value when the company is doing well and punish them, or at least reward them less, when the com-

pany is underperforming. In fact, shareholders are increasingly holding directors accountable for this

responsibility. For example, Ralph Whitworth's Relational Investors forced Home Depot to remove

four directors after accusing them of allowing executive compensation to become divorced from per-

formance (Creswell & Barbaro, 2007; Walker, 2016). Working from this perspective, scholars have

developed a rich body of work on the sensitivity of CEO pay to firm performance (Gerhart, Rynes, &

Fulmer, 2009; Hall & Liebman, 1998). This work typically draws on agency arguments to defend the

notion that CEO pay should reflect past performance (Aggarwal & Samwick, 2003; Leone, Wu, &

Zimmerman, 2006).

There are, of course, a number of things a CEO can do to affect firm performance (Mackey,

2008). The CEO can implement a wide variety of corporate-level strategic actions that establish the

direction of the firm and affect its scope and size (Ireland, Hoskisson, & Hitt, 2014). For instance,

CEOs can quickly grow the firm via acquisitions and business expansion or take a more methodical

approach to growth via internal product development. Management scholars call these kind of invest-

ments “risk-taking expenditures”(Kish-Gephart & Campbell, 2015; Zhu & Chen, 2015) or alterna-

tively refer to them as “resource allocations”(Harrison, Hall, & Nargundkar, 1993) and/or

“investment spending”(Sanders & Hambrick, 2007). Given that research and development (R&D),

acquisitions, and capital expenditures all involve difficult-to-reverse capital outlays aimed at firm

growth, we investigate them collectively as corporate-level strategic investments. We ask: when

making attributions about firm performance (i.e., pay-for-performance), to what extent do boards

account for the CEO's strategic investments?

2048 SHI ET AL.