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Received 14 February 2000
Final revision received 10 October 2001
Key words: executive compensation; firm performance; agency theory; top management teams; cooperation
In this research we discuss the relationship between CEO and top management team (TMT) member compensation, and explore the implications of TMT pay for firm performance. Specifically, we suggest that firm performance may benefit due to agency and group behavioral issues when top management team member pay is aligned-alignment is defined as the degree to which TMT member pay reflects (1) shareholder interests and (2) key political and strategic contingencies within the firm. In support of our theorizing, we found CEO pay to be related to TMT pay; TMT compensation, in turn, predicted performance (i.e., return on assets and Tobin's q) when aligned with shareholder interests and internal contingencies. Moreover, the effect of CEO pay on future firm performance was dependent on top team pay. Copyright © 2002 John Wiley & Sons, Ltd.
Why has top management team (TMT) compensation -the pay of top executives apart from their chief executive officer (CEO)-received so little theoretical or empirical attention? One reason may be that researchers assume the determinants and consequences of top executive pay schemes to be isomorphic with those of the CEO. In that view, theoretical perspectives should be equally applicable to both CEOs and members of top teams. Therefore at the limit, to the extent that firm and industry characteristics actually predict chief executive compensation, there should be a nearly perfect correlation between how CEO and TMT member pay are determined.
However, while research has made the implicit assumption that CEO compensation is a proxy for incentive alignment throughout the firm, there is ample evidence and theory to suggest that senior executive pay schemes are rarely identical (Finkelstein and Hambrick, 1996; Henderson and Fredrickson, 2001). Pragmatists account for such variation in pay by pointing out that the responsibilities of CEOs and other executives overlap, but that their primary roles and areas of expertise tend to be very different. Similarly, tournament theory prescribes large differences in compensation as a way to motivate senior executives in the face of typical agency problems (i.e., difficult to monitor, asymmetric information). Nevertheless, both those views ignore the fact that top managers are generally tasked...