Board Knowledge Breadth and Performance Metric Variety in CEO Bonus Contracts

Abstract

This study examines the role of the board’s knowledge base in explaining a greater variety of performance metrics in CEO bonus contracts. We argue that the board’s knowledge breadth determines how the board conceptualizes the ways in which the CEO creates firm value when selecting metrics for the CEO’s bonus contract. Boards with greater knowledge breadth may identify a larger pool of metrics that are both precise about the dimensions of action that they want to encourage and congruent with firm value, leading to greater performance metric variety in CEO bonus contracts. We further expect this association to become stronger in uncertain environments when designing precise and congruent performance metrics is most complex but also most valuable. Using board functional diversity as a proxy for the board’s knowledge breadth and a newly created measure of performance metric variety, we find a positive association between the boards’ knowledge breadth and performance metric variety, which becomes stronger in uncertain environments. Additional analyses reveal that greater metric variety is associated with improved performance and higher investor support in firms with boards that have a broader knowledge base , especially when environmental uncertainty is high.