Abstract

We study how the existence of important production contracts affects the choice of chief executive officer (CEO) compensation contracts. We hypothesize that having major customers raises the costs associated with CEO risk-taking incentives and leads to lower option-based compensation. Using industry-level import tariff reductions as exogenous shocks to customer relationships, we find that firms with major customers subsequently reduce CEO option-based compensation significantly. We also show that continued high option compensation following tariff cuts is associated with significant declines in these relationships and supplier firm performance. Our study provides new insights into how important stakeholders shape executive compensation decisions.