Independent directors’ reputation incentives and executive pay tournaments

We provide evidence of a positive association between independent directors’ reputation incentives and the magnitude of the CEO pay gap, defined as the difference in compensation between the CEO and lower-ranked executives. The CEO pay gap serves as a proxy for the strength of executive pay tournaments within the firm. Using a sample of S&P 1500 firms, we show that independent directors with stronger reputation incentives employ larger pay gaps to encourage executive risk-taking, thereby enhancing firm performance and protecting their own reputation in the labor market. This relationship holds for both short- and long-term pay gaps and is supported by propensity score matching and difference-in-differences analyses. Cross-sectional results indicate that the association is stronger in settings characterized by higher information asymmetry, lower institutional ownership, weaker product-market competition, and smaller firm size, consistent with reputation incentives substituting for weaker external monitoring. Overall, our findings highlight tournament-based compensation as a strategic governance mechanism and demonstrate that directors’ reputation incentives, particularly in opaque information environments, can help align incentives and improve firm outcomes.