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Executive Compensation Regulation and the Dynamics of the Pay-Performance Sensitivity

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  • Ralf Sabiwalsky
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    Abstract

    A substantial number of empirical studies on the linear relationship between executive compensation and firm performance for European firms suggest that the pay-performance sensitivity is not significantly positive. We argue that a nonlinear structure fits the data better, because compensation contracts provide for minimum performance benchmarks and an upper limit to the variable component of compensation. We test for such discontinuities in the pay performance relationship, and confirm their existence, using hand collected data from German Prime All Share firms’ CEO bonus compensation. It turns out that there is a significant positive relationship between return on assets and CEO bonus for ROA between -3% and +20%. Performance sensitivity is then tested for changes over time between 2006 and 2009. Results reveal that during the first three years after the introduction of a statutory transparency rule in 2005 governing the disclosure of individual CEO compensation, significant changes to compensation contracts did not occur; but that in 2009 the pay-performance sensitivity exhibited a significant increase, which coincides with the passing of a law that requires supervisory boards to ensure that new CEO employment contracts provide for ’reasonable’ compensation.

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    Bibliographic Info

    Paper provided by Sonderforschungsbereich 649, Humboldt University, Berlin, Germany in its series SFB 649 Discussion Papers with number SFB649DP2010-051.

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    Length: 25 pages
    Date of creation: Oct 2010
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    Handle: RePEc:hum:wpaper:sfb649dp2010-051

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    Keywords: Executive Compensation; Regulation; Pay Performance Sensitivity;

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    References

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