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CEO Prior Uncertainty and Pay-Performance Sensitivity

CEOs' pay-performance sensitivity (delta) is higher in the first year after being hired than in the following years. I explain this finding with reference to CEO prior uncertainty: due to information asymmetry and/or uncertainty about the quality of the match between a CEO and a firm, first-year compensation is often arranged to depend largely on performance. Consistent with this explanation, CEOs with higher prior uncertainty exhibit higher first-year delta: First-year delta is higher for outsider CEOs than insider CEOs. Among outsider CEOs, first-year delta is lower for former executives of large public firms and older CEOs. An insider CEO's service time in a firm prior to becoming the CEO reduces first-year delta.