Leadership Style and Incentives

We study the relationship between a firm’s environment and its optimal leadership style. We show that leadership style is a function of the CEO’s personality and affects the firm’s profitability. We use a model in which contracts between the firm (or CEO) and managers are incomplete so that providing incentives to subordinates is not straightforward. The personality of the CEO, and in particular the degree of empathy with other employees, then affects the incentive contracts that can be offered to subordinates. We show that shareholders gain from appointing empathic CEOs, who adopt a participatory style, when the firm has the potential for exploiting numerous innovative ideas. By contrast, when the environment is poor in new ideas, shareholders benefit from hiring a less empathic (profit maximizing) CEO whose style is more autocratic.