Executive
compensation is considered as one of the most crucial issues for the corporate
governance. The proper executive compensation dispersion can be employed to
motivate the top managers and then to boost the firm performance, but the
definition of “proper” varies in the existing literature. The bigger dispersion
is better for firm performance based on Tournament Theory but smaller one is
better according to some other theories. In this paper, we try to theoretically
study the optimal executive compensation by considering the internal and
external situation of the firm at the same time, especially the influence of
product market. We find the optimal compensation dispersion will increase
(decrease) if more (less) firms enter the market when the cost of sabotage increases
more rapidly than the cost of effort, vice versa. The findings imply the firm
should increase (decrease) the compensation dispersion if the intensity of
competition in product market decreases (increases) when sabotage is expensive
and the firm should increase (decrease) the compensation dispersion if the intensity
of competition in product market increases (decreases) when sabotage is cheap.
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