Executive compensation and firm performance: a non-linear relationship
-
DOIhttp://dx.doi.org/10.21511/ppm.17(2).2019.01
-
Article InfoVolume 17 2019, Issue #2, pp. 1-17
- Cited by
- 2817 Views
-
284 Downloads
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.
- Keywords
-
JEL Classification (Paper profile tab)M12
-
References47
-
Tables8
-
Figures9
-
- 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
-
- Abowd, J. M., & Kaplan, D. S. (1999). Executive compensation: six questions that need answering Journal of Economic Perspectives, 13(4), 145-168.
- Allison, P. D. (1994). Using panel data to estimate the effects of events. Sociological Methods & Research, 23(2), 174-199.
- Anabtawi, I. (2005). Some skepticism about increasing shareholder power. UCLA L. Rev, 53, 561.
- Baker, G. P., Jensen, M. C., & Murphy, K. J. (1988). Compensation and incentives: Practice vs. theory. The journal of Finance, 43(3), 593-616.
- Balkin, D. B., & Gomez‐Mejia, L. R. (1987). Toward a contingency theory of compensation strategy. Strategic management journal, 8(2), 169-182.
- Bebchuk, L. A., & Fried, J. M. (2003). Executive compensation as an agency problem. Journal of economic perspectives, 17(3), 71-92.
- Bebchuk, L. A., & Fried, J. M. (2004). Pay without performance: The unfulfilled promise of executive compensation. Harvard University Press.
- Bebchuk, L., & Grinstein, Y. (2005). The growth of executive pay. Oxford review of economic policy, 21(2), 283-303.
- Benston, G. J. (1985). The self-serving management hypothesis: Some evidence. Journal of Accounting and Economics, 7(1-3), 67-84.
- Bertrand, M., & Mullainathan, S. (2001). Are CEOs rewarded for luck? The ones without principals are. The Quarterly Journal of Economics, 116(3), 901-932.
- Bivens, J., & Mishel, L. (2013). The pay of corporate executives and financial professionals as evidence of rents in top 1 percent incomes. The Journal of Economic Perspectives, 27(3), 57-77.
- Bizjak, J. M., Lemmon, M. L., & Naveen, L. (2008). Does the use of peer groups contribute to higher pay and less efficient compensation? Journal of Financial Economics, 90(2), 152-168.
- Bizjak, J., Lemmon, M., & Nguyen, T. (2011). Are all CEOs above average? An empirical analysis of compensation peer groups and pay design. Journal of Financial Economics, 100(3), 538-555.
- Boschen, J. F., & Smith, K. J. (1995). You can pay me now and you can pay me later: The dynamic response of executive compensation to firm performance. Journal of Business, 577-608.
- Boschen, J. F., Duru, A., Gordon, L. A., & Smith, K. J. (2003). Accounting and stock price performance in dynamic CEO compensation arrangements. The Accounting Review, 78(1), 143-168.
- Bruce, A., Skovoroda, R., Fattorusso, J., & Buck, T. (2007). Executive bonus and firm performance in the UK. Long Range Planning, 40(3), 280-294.
- Bussin, M., & Modau, M. F. (2015). The relationship between Chief Executive Officer remuneration and financial performance in South Africa between 2006 and 2012. SA Journal of Human Resource Management, 13(1), 1-18.
- Callan, S. J., & Thomas, J. M. (2014). Relating CEO compensation to social performance and financial performance: Does the measure of compensation matter? Corporate Social Responsibility and Environmental Management, 21(4), 202-227.
- Canarella, G., & Nourayi, M. M. (2008). Executive compensation and firm performance: adjustment dynamics, non‐linearity and asymmetry. Managerial and Decision Economics, 29(4), 293-315.
- Carpenter, M. A., & Sanders, W. M. (2002). Top management team compensation: The missing link between CEO pay and firm performance? Strategic management journal, 23(4), 367-375.
- Chhaochharia, V., & Grinstein, Y. (2009). CEO compensation and board structure. The Journal of Finance, 64(1), 231-261.
- Cho, K. R., Huang, C. H., & Padmanabhan, P. (2014). Foreign ownership mode, executive compensation structure, and corporate governance: Has the literature missed an important link? Evidence from Taiwanese firms. International Business Review, 23(2), 371-380.
- Coughlan, A. T., & Schmidt, R. M. (1985). Executive compensation, management turnover, and firm performance: An empirical investigation. Journal of Accounting and Economics, 7(1-3), 43-66.
- Finkelstein, S. (1992). Power in top management teams: Dimensions, measurement, and validation. Academy of Management journal, 35(3), 505-538.
- Florin, B., Hallock, K. F., & Webber, D. (2010). Executive pay and firm performance: methodological considerations and future directions. In Research in personnel and human resources management (pp. 49-86). Emerald Group Publishing Limited.
- Frydman, C., & Jenter, D. (2010). CEO compensation. Annual Review of Financial Economics, 2, 75-102.
- Frydman, C., & Saks, R. E. (2010). Executive compensation: A new view from a long-term perspective, 1936–2005. The Review of Financial Studies, 23(5), 2099-2138.
- Gabaix, X., Landier, A., & Sauvagnat, J. (2014). CEO pay and firm size: an update after the crisis. The Economic Journal, 124(574), F40-F59.
- Gomez-Mejia, L. R., Balkin, D. B., & Cardy, R. L. (1995). Managing human resources. Upper Saddle River, NJ: Pearson/Prentice Hall.
- Gordon, J. N. (2010). Executive compensation and corporate governance in financial firms: The case for convertible equity-based pay (Columbia Law and Economics Working Paper No. 373).
- Hall, B. J. (2003). Six Challenges in designing equity-based pay. Journal of Applied Corporate Finance, 15(3), 21-33.
- Hall, B. J., & Liebman, J. B. (1998). Are CEOs really paid like bureaucrats? The Quarterly Journal of Economics, 113(3), 653-691.
- Hall, B. J., & Murphy, K. J. (2002). Stock options for undiversified executives. Journal of accounting and economics, 33(1), 3-42.
- Hambrick, D. C., & Finkelstein, S. (1995). The effects of ownership structure on conditions at the top: The case of CEO pay raises. Strategic Management Journal, 16(3), 175-193.
- Jensen, M. C., & Meckling, W. H. (1976). Theory of the firm: Managerial behavior, agency costs and ownership structure. Journal of Financial Economics, 3(4), 305-360.
- Jensen, M. C., & Murphy, K. J. (1990). Performance pay and top-management incentives. Journal of Political Economy, 98(2), 225-264.
- Joskow, P. L., & Rose, N. L. (1994). CEO pay and firm performance: dynamics, asymmetries, and alternative performance measures (No. w4976). National Bureau of Economic Research.
- Kaplan, S. N. (2013). CEO pay and corporate governance in the US: Perceptions, facts, and challenges. Journal of Applied Corporate Finance, 25(2), 8-25.
- Kato, T., & Kubo, K. (2006). CEO compensation and firm performance in Japan: Evidence from new panel data on individual CEO pay. Journal of the Japanese and International Economies, 20(1), 1-19.
- Liker, J. K., Augustyniak, S., & Duncan, G. J. (1985). Panel data and models of change: A comparison of first difference and conventional two-wave models. Social Science Research, 14(1), 80-101.
- Murphy, K. J. (1985). Corporate performance and managerial remuneration: An empirical analysis. Journal of accounting and economics, 7(1-3), 11-42.
- Murphy, K. J. (2012). The politics of pay: A legislative history of executive compensation. Research handbook on executive pay, 11.
- O’Reilly III, C. A., & Main, B. G. (2010). Economic and psychological perspectives on CEO compensation: A review and synthesis. Industrial and corporate change, 19(3), 675-712.
- Pepper, A., & Gore, J. (2014). The economic psychology of incentives: An international study of top managers. Journal of World Business, 49(3), 350-361.
- Shin, T. (2013). Fair Pay or Power Play? Pay Equity, Managerial Power, and Compensation Adjustments for CEOs. Journal of Management, 42(2), 419-448.
- Stock, J. H., & Watson, M. W. (2001). Vector autoregressions. The Journal of Economic Perspectives, 15(4), 101-115.
- Tehranian, H., & Waegelein, J. F. (1985). Market reaction to short-term executive compensation plan adoption. Journal of Accounting and Economics, 7(1-3), 131-144.