Does Cash Bonus Work? A Study on the Contingency Fit with Firm Strategy

Abstract

Compensation research on cash-based incentives is limited due to the escalating value of stock-based incentives in executive compensation. However, firms continue to pay cash bonus to their executives. There are also few empirical studies on contingency-based compensation research, and these studies assume a linear relationship between incentive compensation and performance. In this study, we apply polynomial regression analysis, a more robust statistical tool, to explore the performance impact of the contingency fit between cash bonus awarded to executives (executive cash bonus) and their firm’s strategic orientation (prospector versus defender), using Miles and Snow’s (1973, 2003) typology of business strategy. The results show that there is an inverted U-shaped relationship between executive cash bonus and firm performance, and the matching form of fit applies to both prospector and defender firms. This suggests that cash bonus can be effective to incentivize executives to work to improve performance of both prospector and defender firms, up to a certain level at which firm performance is optimized. We also find that performance of prospector firms is more responsive to changes in executive cash bonus than performance of defender firms up to the optimal level of executive cash bonus. Thus, despite the popularity of stock-based incentives, cash bonus remains an effective tool to incentivize executives of both prospector and defender firms to work hard to improve firm performance, but it may not be an efficient tool for executives of prospector firms.