Research summary: This article investigates how corporate spinoffs affect managerial compensation. These deals are found to improve the alignment of spinoff firm managers' incentive compensation with stock market performance, especially among spinoff firm managers that used to be divisional managers of the spun‐off subsidiary, and particularly when the spun‐off subsidiary performs better than or is unrelated to its parent firm's remaining businesses. By contrast, incentive alignment does not improve for the parent firm managers running the divesting companies. This finding appears to be driven by a significant post‐spinoff increase in these managers' incentive compensation, the magnitude of which is inversely related to governance quality in their firms. Together, these results elucidate how spinoffs influence managerial compensation in diversified firms and the companies they divest. Managerial summary: This article explores how spinoffs affect incentive alignment: the correlation between incentive compensation and stock market performance. The incentive alignment of spinoff firm managers improves following these deals. These gains are the largest when spinoff firm managers used to be divisional managers of the spun‐off subsidiary and when the spun‐off subsidiary performs better than or is unrelated to the other businesses in the parent firm. By contrast, incentive alignment does not improve for parent firm managers. Instead, the level of these managers' incentive compensation rises significantly post‐spinoff, and the magnitude of this increase is inversely related to governance quality in these firms. Together, these results shed light on the ways in which spinoffs influence managerial compensation in diversified firms and in the companies they divest. Copyright © 2015 John Wiley & Sons, Ltd.