Incentive Compensation and Complex Outsourcing

This study addresses the relationship between incentive compensation and complex outsourcing in somewhat different vein. The agency theory suggests, firstly that managers are constantly faced with allocation of efforts and choices and within this context their decisions are driven by incentive compensation. Secondly, task complexity increases the noise associated with performance measures and is negatively related to incentive compensation. The literature findings suggest that when firms are confronted with complex tasks, it is better for the firm to delegate the task to the manager with strong incentive contracts in place. We extend these findings by testing outsourcing as an alternative choice for a risk-averse manager when faced with complex tasks in an uncertain environment. This study further places CEO turnover, firm characteristics, and financial indicators into focus to test the association between outsourcing decisions and CEO compensation. Prendergast’s (2002) framework is used to examine whether outsourcing plays a mediating role between task complexity and incentive contracting. The study proposes the delegation of complex tasks as a means to align the agents’ interests with those of the principals’.