Optimizing Executive Cash Bonuses: The Nonlinear Impact of Executive Cash Bonuses and Strategic Fit

ABSTRACT This study examines how aligning executive cash bonuses with firm strategic orientation influences firm performance. While prior research mainly focuses on stock‐based incentives and linear effects, we address critical gaps by analyzing cash bonuses and exploring nonlinear relationships using polynomial regression and response surface analysis. We adopt Miles and Snow's typology and focus on prospector and defender firms, representing the two ends of the strategic continuum. Our findings indicate that aligning executive cash bonuses and firm strategy significantly enhances future performance. Neither cash nor stock incentives alone, without strategic alignment, substantially improve performance. Polynomial regression results reveal an inverted U‐shaped relationship between executive cash bonuses and firm performance. Performance improves with cash bonuses up to roughly 50% of total compensation, beyond which further increases become counterproductive, potentially demotivating executives or encouraging inefficient strategies, especially in efficiency‐oriented defender firms. Moreover, the surface analysis shows that the effect of the optimal bonus threshold differs by strategic type, with innovation‐oriented prospector firms reacting more sensitively to cash bonus levels than defenders. These findings advance compensation and management control literature by highlighting the importance of strategic alignment and emphasizing a nonlinear relationship between executive cash bonuses and firm performance. Practically, our research offers important insights into designing effective compensation structures tailored to a firm's strategic orientation.