Abstract
This study examines the relationship between CEO incentive-based compensation and firm performance, based on the role of prospect theory in executive compensation. Our results indicate that moderate levels of performance-based CEO compensation are generally optimal. When an executive's total compensation package is based more on firm performance there is often a level of higher returns, but to a point of diminishing return. Our findings suggest that boards must clearly communicate with CEOs to determine the most appropriate levels of incentive-based compensation. Additional managerial and theoretical implications are offered, as well as avenues for future research.