Executive compensation and firm performance: a non-linear relationship

  • Received October 4, 2018;
    Accepted March 20, 2019;
    Published April 16, 2019
  • Author(s)
  • DOI
    http://dx.doi.org/10.21511/ppm.17(2).2019.01
  • Article Info
    Volume 17 2019, Issue #2, pp. 1-17
  • TO CITE АНОТАЦІЯ
  • Cited by
    6 articles
  • 2843 Views
  • 288 Downloads

Creative Commons License
This work is licensed under a Creative Commons Attribution 4.0 International License

In order to ensure profitability for shareholders, optimal contracting recommends the alignment between executive compensation and company performance. Large organizations have therefore adopted executives remuneration systems in order to induce positive market reaction and motivate executives. Complex compensation schemes are designed by Boards of Directors using strong pay-performance incentives that explain high levels of executive pay along with company size, demand for management skills and executive influence. However, the literature remains inconclusive on the pay-performance relationship owing to the various empirical methods used by researchers. Additionally, there has been little effort in the literature to compare methodologies on the pay-performance relationship.
Using the dominant agency theory framework, the purpose of this study is to establish and examine the relationship between firm performance and executive pay. In addition, it intends to assess the characteristic of model specifications commonly adopted. To this aim, a quantitative analysis consisting of three complementary methods was performed on panel data from South African listed companies. The results of the main unrestricted first difference model indicate a strong non-linear relationship where the impact of current and previous firm performance on executive pay can be observed over 2 to 4-year period providing support to the optimal contracting theoretical perspective in the South African business context. In addition, CEO pay is more sensitive to firm performance as compared to Director pay. Lastly, although it affects executive pay levels, company size is not found to improve the pay-performance relationship.

view full abstract hide full abstract
    • Figure 1. Executive pay composition
    • Figure 2. Evolution of median executive total pay
    • Figure 3. Pay to earnings ratio in large companies
    • Figure 4. Pay to earnings ratio in medium companies
    • Figure 5. Pay to earnings ratio in small companies
    • Figure 6. The response of CEO total pay to market returns
    • Figure 7. The response of Director total pay to market returns
    • Figure 8. Response of CEO and Director cash pay to ROE
    • Figure 9. CEO pay to Director pay ratio
    • Table 1. Executive pay growth 2005–2016
    • Table 2. Results of the multivariate analysis for CEO pay
    • Table 3. Results of the multivariate analysis for Director pay
    • Table 4. Summary of the cumulative effect of a 10% change in performance on pay
    • Table 5. CEO and Director cash pay to ROE
    • Table 6. CEO and Director cash pay to ROA
    • Table 7. CEO and Director total pay to ROA
    • Table 8. CEO and Director total pay to market returns