Paper #1132

Title:

Illusory correlation in the remuneration of chief executive officers: It pays to play golf, and well

Authors:

Gueorgui I. Kolev and Robin Hogarth

Date:

December 2008

Abstract:

Illusory correlation refers to the use of information in decisions that is uncorrelated with the relevant criterion. We document illusory correlation in CEO compensation decisions by demonstrating that information, that is uncorrelated with corporate performance, is related to CEO compensation. We use publicly available data from the USA for the years 1998, 2000, 2002, and 2004 to examine the relations between golf handicaps of CEOs and corporate performance, on the one hand, and CEO compensation and golf handicaps, on the other hand. Although we find no relation between handicap and corporate performance, we do find a relation between handicap and CEO compensation. In short, golfers earn more than non-golfers and pay increases with golfing ability. We relate these findings to the difficulties of judging compensation for CEOs. To overcome this – and possibly other illusory correlations – in these kinds of decisions, we recommend the use of explicit, mechanical decision rules.

Keywords:

Illusory correlation, executive compensation, golf handicaps, decision rules, LeeX

JEL codes:

D03, D81, J33

Area of Research:

Behavioral and Experimental Economics

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