Does Firm Heterogeneity Lead to Differences in Relative Executive Compensation?

Cost heterogeneity is an important source of performance disparity. Hence, executive compensation contracts that account for relative performance must be adjusted for cost differences. I investigate this effect in two strategic product market environments in which firms can compete using either Bertrand or Cournot strategies. Both models predict that, depending on cost heterogeneity, the incentive packages of CEOs of more efficient firms deviate significantly from industry standard executive compensation. For example, cost differences in the Bertrand (Cournot) model may lead shareholders of efficient firms to give incentives for managers to be more (less) aggressive as products become more substitutable, whereas managers of less efficient firms have incentives to always soften (harden) market competition. ∗I am grateful to Leslie Marx for many detailed comments and suggestions. I also thank Rui Albuquerque and Evgeny Lyandres for helpful discussions.