Why CEO Option Compensation Can be a Bad Option for Shareholders: Evidence from Major Customer Relationships

Abstract

We study how the existence of important production contracts affects the choice of CEO compensation contracts. We hypothesize that having major customers raises the costs associated with CEO risk-taking incentives and leads to lower option-based compensation. Using industry-level import tariff reductions in the U.S. as exogenous shocks to customer relationships, we find firms with major customers subsequently reduce CEO option-based compensation significantly. We also show that continued high option compensation following tariff cuts, is associated with significant declines in these relationships and in these firms’ performance. Our study provides new insights into how important stakeholders shape executive compensation decisions.

Keywords: Compensation, Firm Performance, Product Market, Risk Taking, Supply Chain

JEL Classification: G30, J33, L22