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CEO Pay and Firm Performance: Dynamics, Asymmetries, and Alternative Performance Measures
Abstract
This study explores the dynamic structure of the pay-for- performance relationship in CEO compensation and quantifies the effect of introducing a more complex model of firm financial performance on the estimated performance sensitivity of executive pay. The results suggest that current compensation responds to past performance outcomes, but that the effect decays considerably within two years. This contrasts sharply with models of infinitely persistent performance effects implicitly assumed in much of the empirical compensation literature. We find that both accounting and market performance measures influence compensation and that the salary and bonus component of pay as well as total compensation have become more sensitive to firm financial performance over the past two decades. There is no evidence that boards fail to penalize CEOs for poor financial performance or reward them disproportionately well for good performance. Finally, the data suggest that boards may discount extreme performance outcomes -both high and low - relative to performance that lies within some `normal' band in setting compensation.
... The main model for the study is the unrestricted first difference model (Joskow & Rose, 1994) which is simplified for the study into: ...
... where t represents time, i represents executive, t α is a constant which represents non-performance related pay, 0 β is the response of pay to performance at each period, it X represents performance, and it ε represents a random error term (Joskow & Rose, 1994). ...
... The cumulative response is larger than the short-term response (p-value of 0.008, F-statistic significant, Durbin-Watson statistics of 2.1). The squared correlation of this non-linear relationship is low and consistent with Joskow and Rose (1994) unrestricted model statistics. The results general-ly support the notion that CEO pay is linked to shareholders' returns according to optimal contracting theory. ...
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.
... They further concluded that the salary gap certainly plays a role in promoting the business environment. Joskow and Nancy [1994] exploring through an empirical analysis reported a positive correlation between executive stock ownership and firm performance, and such an absolute pay gap has a much stronger incentive to overall organizational performance. Main et al. [1993], based on the investigation in 210 US firms from 1980 to 1984, found that the pay gap between the executives has a positive impact on the total asset yield and return on equity. ...
... Cowherd and Levine [1992] reported that the salary gap between the lower level staffs and executives has a significant negative impact on work quality. Joskow and Nancy [1994] and Reeves et al. [2009] agreed that the timely narrowing of pay gap between senior executives and ordinary employees can promote the development of enterprises and improve performance. Mason et al. [2004] confirmed that the pay gap between the CEO and other executive members has a negative influence on organizational performance. ...
The study aims at identifying the influence of interior pay gap between senior executives and ordinary employees on the organization’s future performance for listed Chinese firms. In addition, two other moderator variables have been included in the study referring management power as the percentage of senior managers holding “A” category shares for more than one position. The other one is managerial overconfidence defined as the change in management holdings by themselves (managers) positively. The paper is based on secondary data extracted from China’s ‘A’ listed companies in Shanghai and Shenzhen Stock Exchanges with a valid sample size of 1,189. After detailed analysis (Pearson correlation and regression) between the variables, it was found that there is a moderate positive relationship between the pay gap and firms’ future performance. The results further indicate that management power and overconfidence weaken the relationship between pay gap and corporate performance. The authors hope that this empirical study can guide the academicians intending to further excavate in this relatively uncharted area as well as the corporate body and top managers who seek some guidelines to formulate an effective pay plan.
... Therefore, the committee should be compensated with a reasonable compensation structure to motivate them to protect shareholders' interests. Contrary to equity-based incentives, cash-based compensation is only indirectly linked to firm financial performance (Joskow & Rose, 1994) and is not tied to stock price (firm market performance); thus, it is less likely to drive directors to engage in self-interested actions. However, prior studies find mixed results on the effect of cash compensation on earnings management, which may be positive or negative (Campbell et al., 2015;Rickling & Sharma, 2017;Ye, 2014). ...
... Jensen and Murphy (2010) also proposed that the compensation of CEO'S in most public companies is highly associated with organizational performance. Rose and Joskow, (1994) found that past performance influences not only cash compensation, but also total compensation. In line with Jensen and Murphy, they found that the lagged performance effect decays considerably over two to three years. ...
This study examined the link between organizational performance and CEO’S compensation of firms listed at the NSE. Past studies on the determinants of CEO’S compensation revealed a lack of consensus to the explanation of increases in CEO’S compensation. While most of the studies confirm linkages between organizational performance and CEO’S compensation, they measured organizational performance using financial indicators of performance, the current study investigates the relationship between organizational performance and CEO’S compensation but differs from the previous studies by expanding the measures of organizational performance to include the balanced scorecard measures of performance. The theoretical foundations of this study were based on agency theory. The study’s population constituted 60 firms listed at the NSE. Descriptive crossectional survey was adopted for this study. Both Primary and Secondary data were used to gather information required for the study. Descriptive statistics and regression were used to analyze and interpret the collected data. The study revealed that there wassignificant and positive relationship between organizational performance and CEO’S compensation. The findings of this study are of benefit to board members of organizations in identifying the performance measures that are important to consider when making decisions on CEO’S compensation.
... Their results indicated that past performance has a positive and significant effect on current compensation. Evidence from Joskow and Rose (1994) shows that past performance influences not only cash compensation, but also total compensation. ...
... Jensen and Murphy (2010) also proposed that the compensation of CEO'S in most public companies is highly associated with organizational performance. Rose and Joskow, (1994) found that past performance influences not only cash compensation, but also total compensation. In line with Jensen and Murphy, they found that the lagged performance effect decays considerably over two to three years. ...
This study examined the link between organizational performance, firm size and CEO’S compensation of firms listed at the NSE. Past studies on the determinants of CEO’S compensation revealed a lack of consensus to the explanation of increases in CEO’S compensation. While most of the studies confirm linkages between organizational performance and CEO’S compensation, they measured organizational performance using financial indicators of performance, the current study investigates the relationship between organizational performance and CEO’S compensation but differs from the previous studies by expanding the measures of organizational performance to include the balanced scorecard measures of financial indicators, customer satisfaction, internal processes and learning and growth elements of performance. Additionally, the study sought to find out the moderating role of firm size on the relationship between organizational performance and CEO’S compensation. The theoretical foundation of this study was based on agency theory. A conceptual model and conceptual hypothesis were drawn from literature and provided directions for this study. The study’s population constituted 60 firms listed at the NSE. Descriptive crossectional survey was adopted for this study. Primary data was collected to capture the opinion of board members on factors that determine levels of CEO’S compensation using semi structured questionnaire. Secondary data was gathered from the financial statements of the listed firms for 2015-2016 financial periods. Descriptive statistics and stepwise regression were used to analyze and interpret the collected data. The study revealed that there was significant and positive relationship between organizational performance and CEO’S compensation. The study further found that firm size had a significant moderating effect on the relationship between organizational performance and CEO’S compensation.
... The main argument is that there is a possibility for powerful executives to be insulated from bad luck while they are hugely rewarded for good luck ( Jouber and Fakhfakh, 2011;Garvey and Milbourn, 2006). It has been keenly debated that instead for CEO pay to serve as a corporate governance mechanism to alleviate the agency problem, it may turn out to be part of agency problem (Bebchuk and Fried, 2003;Joskow and Rose, 1994;Obembe, 2015, 2017). Studies that examined asymmetric information process in the link between CEO pay and firm performance are sparse. ...
Purpose
The purpose of this paper is to examine the asymmetric behavior between CEO pay and firm performance in Nigeria.
Design/methodology/approach
The study adopts a two-step dynamic panel generalized method of moments (GMM) to reveal asymmetric responses of CEO pay to positive and negative shocks in firm performance.
Findings
The research outcomes of a two-step dynamic panel GMM) adopted reveal asymmetric responses of CEO pay to positive and negative shocks in firm performance. This implies that CEOs are handsomely compensated for good performance, but not punished for poor performance.
Originality/value
The study, therefore, suggests that CEO pay fails to serve as an internal corporate governance mechanism to alleviate agency problem in Nigeria’s listed firms.
This paper investigates the relationship between the audit committee’s cash compensation and accrual earnings management. Using a sample of Chinese listed firms over the period 2007 to 2017, findings show a positive association between cash compensation of the audit committee and accrual earnings management. It suggests that high cash compensation to audit committee directors compromises their monitoring role related to financial reporting quality, and high cash compensation to audit committee’s directors leads to an alignment in the audit committee’s interests with those of managers. We also examine the implications of ownership structure and institutional environment on this relationship. Results show that state-ownership significantly moderates the association between the audit committee’s cash compensation and accrual earnings management. We also investigate whether this relationship is influenced by the regional development level or not. Results reveal no difference in this positive association for firms located in more versus less developed regions. Our findings can be of broad interest to regulators in improving corporate governance.
Die vorliegende Arbeit beschäftigt sich mit dem Zusammenhang der Vorstandsvergütung zu der Unternehmensleistung, gemessen an der Veränderung des Unternehmenswerts, im Kontext der Prinzipal-Agenten- und der Managerialismustheorie. Auch ein Einfluss des Aufsichtsrates auf die Höhe der Vergütung wird näher betrachtet. Die Untersuchungen zeigen zunächst eine Steigerung des Grundgehalts eines Vorstandes, wenn sich der Unternehmenswert im Vorjahr positiv entwickelt hat. Dies lässt darauf schließen, dass die Entwicklung des Unternehmenswerts ein Kriterium bei Gehaltsverhandlungen darstellt. Untersuchungen, die die Leistungsabhängigkeit der Vergütung diskriminiert nach der Entwicklung der Unternehmensleistung betrachten, konnten keine eindeutigen Ergebnisse liefern. So konnte nicht festgestellt werden, dass die Erfolgsabhängigkeit von der Vergütung mit der erbrachten Leistung in Verbindung steht. Auch die Untersuchung der Eigenschaften des Aufsichtsrates in Bezug auf die Vorstandsvergütung ergab ambivalenteErgebnisse. So konnte die Annahme, eine hohe Verhandlungsmacht des Aufsichtsrates führe zu einer niedrigeren Vergütung, nicht final bestätigt werden. Jedoch zeigt sich, dass die Vergütung der Vorstandsmitglieder niedriger angesetzt wird, wenn der Aufsichtsratsvorsitzende Teil des Vorstandes ist.
This paper compares CEO and top management turnover and its relation to firm performance in the largest companies (by sales) in Japan and the U.S. Japanese top managers are older and have shorter tenures as top managers than their U.S. counterparts. Overall, however, turnover-performance relations are economically and statistically similar: turnover is negatively related to stock, sales, and earnings performance in both countries. Turnover in Japan is particularly sensitive to low earnings. Evidence on executive compensation confirms that Japanese executives own less stock and receive lower cash compensation than U.S. executives. Cash compensation performance relations, nevertheless, are also similar in magnitude to those found in previous work for U.S. executives.Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.
Economic theories of efficient compensation predict a positive relationship between executive pay and corporate performance, and yet efforts to document this relationship have been largely unsuccessful. In this paper, we argue that previous cross-sectional studies have omitted important variables which seriously bias their results. Using data that focus on individual executives over time, we find that executive compensation is strongly positively related to corporate performance as measured by shareholder return and growth in firm sales. The results are robust to the stock market performance measure utilized.
It is commonly observed that the compensation paid to senior level executives depends on both accounting and security price measures of performance. The articles by Kim and Suh, Bushman and Indjejikian, and Sloan, which I have been invited to discuss, examine the issue of how much weight to place on these two measures in the contract. The first two papers analyze the role that earnings can play in removing the ‘noise’ in stock price in a rational expectations pricing model. The Sloan paper analytically and empirically examines the role that earnings can play in removing macroeconomic factors from stock price.
The authors' estimates of the pay-performance relation (including pay, options, stockholding, and dismissal) for chief executive officers indicate that CEO wealth changes $3.25 for every $1,000 changes in shareholder wealth. Although the incentives generated by stock ownership are large relative to pay and dismissal incentives, most CEOs hold trivial fractions of the firms' stock, and ownership levels have declined over the past fifty years. The authors hypothesize that public and private political forces impose constraints that reduce the pay-performance sensitivity. Declines in both the pay-performance relation and the level of CEO pay since the 1930s are consistent with this hypothesis. Copyright 1990 by University of Chicago Press.