Sales-Based CEO Incentives and Their Effect Across the Supply Chain

ABSTRACT

I examine how the use of sales performance measures in CEO incentive contracts affects the operations of a firm and its suppliers. A growing number of firms are evaluating and compensating their CEOs based on sales performance. However, because sales performance measures are narrow measures that do not incentivize cost control, they can influence operational decisions that affect not only the firm but also its suppliers. I show that the use of sales performance measures in CEO bonus contracts is associated with inventory fluctuations that increase the bullwhip effect, a phenomenon in which a firm exhibits greater volatility in production than in demand, thereby increasing the order volatility faced by its suppliers. Instrumental variable tests using the firm’s network connections through compensation consultants mitigate concerns that the results are driven by omitted factors. Collectively, my findings illuminate spillover effects of CEO incentive contracts on economically linked firms.

Data Availability: Data are available from the sources cited in the text.

JEL Classifications: M10; M12; M40; M41; M52.