We analyze the costs and benefits of subjective performance evaluation of
executives relative to objective performance measures. We formulate hypotheses
based on the theoretical work on discretionary compensation and test these
hypotheses empirically using a proprietary dataset of executive bonus plans.
We show that discretion is less important in determining CEO pay than the pay
of other executives. We also find that discretion is relatively important at
larger and private firms and that more diversified firms are less likely to
compensate business unit managers based on firm-wide performance. Finally, we
consider (and largely dismiss) tax-related explanations for our results.
DISCRETION IN EXECUTIVE INCENTIVE CONTRACTS