Top management team incentive heterogeneity, strategic investment behavior, and performance: A contingency theory of incentive alignment

• DOI: http://doi.org/10.1002/smj.2628
• Author: Albert A. Cannella,Tim R. Holcomb,Cynthia E. Devers,R. Michael Holmes,Adam L. Steinbach
• Published date: 01 August 2017
• Date: 01 August 2017

Strategic Management Journal

Strat. Mgmt. J.,38: 1701–1720 (2017)

Published online EarlyView 19 January 2017 in Wiley Online Library (wileyonlinelibrary.com) DOI: 10.1002/smj.2628

Received 2 February 2011;Finalrevision received 22 November 2016

TOP MANAGEMENT TEAM INCENTIVE

HETEROGENEITY, STRATEGIC INVESTMENT

BEHAVIOR, AND PERFORMANCE: A CONTINGENCY

THEORY OF INCENTIVE ALIGNMENT

ADAM L. STEINBACH,1TIM R. HOLCOMB,2R. MICHAEL HOLMES JR.,3

CYNTHIA E. DEVERS,4*and ALBERT A. CANNELLA JR.4

1Management Department, Darla Moore School of Business, University of South

Carolina, Columbia, South Carolina, U.S.A.

2Institute for Entrepreneurship and Department of Management & Leadership,

Farmer School of Business, Miami University, Oxford, Ohio, U.S.A.

3Department of Management, College of Business, Florida State University,

Tallahassee Florida, U.S.A.

4Department of Management, Mays Business School, Texas A&M Univer sity,

College Station, Texas, U.S.A.

Research summary: Wedevelop and test a contingency theory of the inuence of top management

team (TMT) performance-contingent incentives on manager– shareholder interest alignment.

Our results support our theory by showing that although TMTs engage in signicantly higher

levels of acquisition investment when their average incentive levelsincrease, investors’ responses

to those large investments are generally negative. More importantly, however, we further nd

that within-TMT incentive heterogeneity conditions that effect, such that investors evaluate

TMTs’ large acquisition investments more positively as the variance in those top managers’

incentive values increases. Thus, within-TMT incentive heterogeneity appears to increase

manager– shareholderinterest alignment, in the context of large acquisition investments.

Managerial summary: We nd that as the average value of TMTs’ incentives increase, relative

to their total pay, they invest more in acquisitions and investors’ respond negatively to the

announcement of those deals. However, we further show that investors respond more positively

to acquisitions announced by TMTs whose members’ incentive values vary (some TMT members

hold higher incentives and others hold lower). Results imply that when TMT members hold

differing incentives levels, they approachinvestments from divergent perspectives, scrutinize those

investments more heavily, and make better decisions, relative to TMTs with similar incentives.

They also suggestthat boards seeking tighter manager –shareholder interest alignment may benet

from introducing variance into TMT members’incentive structures, as doing so appears to create

divergent preferences that can improve team decision making. Copyright © 2016 John Wiley &

Sons, Ltd.

Keywords: top management team decision making; acqui-

sitions; corporate governance; upper echelons; executive

compensation

*Correspondence to: Cynthia E. Devers, Department of Man-

agement, Mays Business School, Texas A&M University, 420

Wehner Building, College Station, TX 77842-4221, U.S.A.

E-mail: cdevers@mays.tamu.edu

Copyright © 2016 John Wiley & Sons, Ltd.

INTRODUCTION

Organizational theorists have long recognized

the importance of aligning managers’ interests

with those of their employing organizations

(cf., Barnard, 1938). Because monitoring and

evaluating managerial behavior is difcult and

expensive, incentive alignment proponents suggest

1702 A. L. Steinbach et al.

an alternative— aligning those interests through

reward systems that link a portion of managers’

pay to observable rm outcomes (Bottom et al.,

2006; Gerhart and Rynes, 2003). In the past few

decades, corporate governance and executive

compensation scholars from several elds have

drawn on incentive alignment arguments to defend

or even advocate the use of conditional rewards,

such as stock options, restricted stock, and bonus

plans that tie top management team (TMT) pay to

rm returns (Finkelstein, Hambrick, and Cannella,

2009). Under this view, top managers are assumed

to be naturally risk averse, and, unless incentivized

to do otherwise, prefer conservative investments

that pose minimal threats to their future compen-

sation and employment, yet create agency costs

for risk-neutral shareholders (Hall and Liebman,

1998; Jensen and Meckling, 1976). Thus, incentive

alignment proponents argue that high levels of

incentives should improve manager–shareholder

interest alignment by motivating inherently

self-interested managers to enhance their per-

sonal wealth through investments that increase

shareholder wealth (Eisenhardt, 1989). Thus far,

however, growing evidence has challenged this

hypothesis (Devers et al., 2013; Finkelstein etal.,

2009; Sanders and Hambrick, 2007).

In this study, we advance a contingency theory

of incentive alignment, in which the variance

in TMT members’ incentive portfolio values

(within-TMT incentive heterogeneity) conditions

the inuence of performance-contingent incentives

on manager– shareholder interest alignment. We

develop our theory by drawing on research exam-

ining the inuence of incentive levels on top man-

agers’ strategic investments. This work has shown

that when CEOs hold high levels of incentives, they

often make overly risky strategic investments that

compromise shareholders’ interests. Conversely,

this research also suggests that managers who are

not highly incentivized will favor strategic invest-

ments that are more conservative than fully diversi-

ed investors would prefer,which can also misalign

interests (Datta, Iskandar-Datta, and Raman,2001;

Devers et al., 2008; Larcker, 1983). We contribute

to this line of work in two ways. First, we extrap-

olate these ndings to the team level to argue that

when TMTs hold high average incentive levelsthey

are more likely to make larger, rm-risk-increasing

strategic investments that investors evaluate poorly,

relative to when they hold low average incentive

levels. Second, we further advance this research

by moving beyond average incentive levels, to

examine how within-TMT incentive heterogeneity,

or the variance among TMT members’ incentive

portfolio levels, inuences the association between

average TMT incentives and TMT strategic

investments. Specically, as earlier noted, high

and low incentives can motivate top managers to

evaluate strategic alternatives differently (Finkel-

stein et al., 2009). It follows, then, that members

within the same TMT may favor divergent strategic

actions when their incentive levels differ.

We draw on group decision-making research

to build theory regarding how within-TMT incen-

tive heterogeneity may inuence the impact of

TMTs’ average incentive levels on their strate-

gic investments and investors’ evaluations of those

actions. Specically, group decision-making work

has shown that team members with heterogeneous

preferences tend to raise and debate more divergent

issues during decision-making processes than do

teams with more homogeneous preferences (Ama-

son and Sapienza, 1997; Miller, Burke, and Glick,

1998; Milliken and Martins, 1996; Williams and

O’Reilly, 1998). Because such discourse increases

members’ scrutiny of issues, within-group hetero-

geneity can slow decision consensus (Amason,

1996; Eisenhardt and Schoonhoven, 1990; Jehn,

1995; Michel and Hambrick, 1992; Simsek et al.,

2005). At the same time, under some conditions, the

less harmonious evaluation that within-team het-

erogeneity motivates can mitigate decision errors

and, in turn, increase outcome quality (Jehn, 1995;

Moon et al., 2003; Pelled, Eisenhardt, and Xin,

1999; Simons and Peterson, 2000).

As earlier noted, although we expect TMTs with

high average incentives to make strategic invest-

ments that investors evaluate negatively, building

on the group decision-making research above, we

propose that within-TMT incentive heterogeneity

attenuates this effect. We test our theory in the con-

text of acquisition investments. Our results support

these predictions.

We believe our ndings advance the strategic

management literature in three important ways.

First, prior research on executive compensation

tends to assume that although TMT colleagues’

total compensation values may vary, their pay

packages are similarly structured, such that they

hold comparable proportions of contingent and

noncontingent compensation (Finkelstein et al.,

2009). Thus, while an extensive body of research

Copyright © 2016 John Wiley & Sons, Ltd. Strat. Mgmt. J.,38: 1701–1720 (2017)

DOI: 10.1002/smj