Agency, Firm Growth, and Managerial Turnover

Abstract

We study managerial incentive provision under moral hazard when growth opportunities arrive stochastically and pursuing them requires a change in management. A trade-off arises between the benefit of always having the “right” manager and the cost of incentive provision. The prospect of growth-induced turnover limits the firm's ability to rely on deferred pay, resulting in more front-loaded compensation. The optimal contract may insulate managers from the risk of growth-induced dismissal after periods of good performance. The evidence for the United States broadly supports the model's predictions: Firms with better growth prospects experience higher CEO turnover and use more front-loaded compensation.