This paper studies the relationship between firms’ use of incentive compensation and
managerial autonomy, as well as how managerial autonomy affects firm performance. We
develop a simple framework in which the principal employs compensation contract and
delegation of autonomy to balance the tradeoff between delegation benefits and agency
costs. We conduct the empirical analysis using Investment Climate Survey data from China.
Our results show that: (i) firm’s use incentive compensation is negatively associated with
general manager’s investment decision autonomy but positively associated with labor
decision autonomy; (ii) general manager’s investment decision autonomy dampens, while
labor decision autonomy boosts firm performance.