Previous empirical analyses of the relationship between executive compensation and firm performance are often interpreted as suggesting that this relationship is weak. Although an absolute term like "weak" is ambiguous in this context, relative terms, such as "stronger," are meaningful. We argue that a stronger relationship can be found if a more appropriate specification is used in estimation. Specifically, an implicit assumption in the previous literature is that all firms use the same compensation scheme. Theoretically, this is a difficult assumption to accept. Moreover, we show that it is rejected empirically as well. When we allow different firms to use different compensation schemes, we indeed find a relationship between executive pay and firm performance that is about 2.8 times larger than that found using previous methods.
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Paper provided by EconWPA in its series Finance with number
9710006.
Length: 27 pages Date of creation: 31 Oct 1997 Date of revision: Handle: RePEc:wpa:wuwpfi:9710006
Note: Type of Document - PDF file (figures in Newtable2.pdf); prepared on IBM PC ; pages: 27 ; figures: In PDF format in file Newtable2.pdf Contact details of provider: Web page: http://129.3.20.41
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Find related papers by JEL classification: D21 - Microeconomics - - Production and Organizations - - - Firm Behavior G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Mortgages G39 - Financial Economics - - Corporate Finance and Governance - - - Other J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods
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