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The Link Between CEO Compensation and Firm Performance: Does Simultaneity Matter?

  • Matthew Lilling
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    In order to combat the principle-agent problem, directors of public companies use incentive-based contracts to align the interests of CEOs and shareholders. Some studies suggest that these contracts are an inefficient use of resources, and that they do not motivate CEOs to do what is best for the firm. In this study, the author estimates a regression to find the relationship between CEO Compensation and market value of a firm. In order to address persistence, endogeneity and firm-specific effects the author uses the first-differenced and system GMM regression techniques first used by [Arellano, M.; Bover, O. “Another Look at the Instrumental-Variable Estimation of Error-Component Models,” Journal of Econometrics, 68, 1995, pp. 29–51] and [Blundell, R. W.; Bonds, S. R. “Initial Conditions and Moment Restrictions in Dynamic Panel Data Models,” Journal of Econometrics, 87, 1998, pp. 115–43; Blundell, R. W.; Bond, S. R., Windmeijer, F. “Estimation in Dynamic Panel Data Models: Improving on the Performance of the Standard GMM Estimators,” Institute for Fiscal Studies Working Paper W00/12, London, England, 2000]. These regressions report a positive relationship between CEO compensation and market value of a firm. This study concludes that incentive based contracts are effective, due to the positive pay-to-performance link, when controlling for simultaneity. Copyright International Atlantic Economic Society 2006

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    Article provided by International Atlantic Economic Society in its journal Atlantic Economic Journal.

    Volume (Year): 34 (2006)
    Issue (Month): 1 (March)
    Pages: 101-114

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    Handle: RePEc:kap:atlecj:v:34:y:2006:i:1:p:101-114
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    1. Robert Gibbons & Kevin J. Murphy, 1991. "Optimal Incentive Contracts in the Presence of Career Concerns: Theory and Evidence," NBER Working Papers 3792, National Bureau of Economic Research, Inc.
    2. Jensen, M.C. & Murphy, K.J., 1988. "Performance Pay And Top Management Incentives," Papers 88-04, Rochester, Business - Managerial Economics Research Center.
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    8. Beck, Thorsten & Levine, Ross & Loayza, Norman, 1999. "Finance and the sources of growth," Policy Research Working Paper Series 2057, The World Bank.
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    14. Anderson, Ronald C. & Bizjak, John M., 2003. "An empirical examination of the role of the CEO and the compensation committee in structuring executive pay," Journal of Banking & Finance, Elsevier, vol. 27(7), pages 1323-1348, July.
    15. Richard Blundell & Steve Bond & Frank Windmeijer, 2000. "Estimation in dynamic panel data models: improving on the performance of the standard GMM estimator," IFS Working Papers W00/12, Institute for Fiscal Studies.
    16. Bebchuk, Lucian A. & Fried, Jesse M., 2003. "Executive Compensation as an Agency Problem," Berkeley Olin Program in Law & Economics, Working Paper Series qt81q3136r, Berkeley Olin Program in Law & Economics.
    17. Roger Koenker & Kevin F. Hallock, 2001. "Quantile Regression," Journal of Economic Perspectives, American Economic Association, vol. 15(4), pages 143-156, Fall.
    18. Mahmut Yasar & Carl H. Nelson & Roderick Rejesus, 2003. "The Dynamics of Exports and Productivity at the Plant Level: A Panel Data Error Correction Model (ECM) Approach," Emory Economics 0322, Department of Economics, Emory University (Atlanta).
    19. Paul L. Joskow & Nancy L. Rose, 1994. "CEO Pay and Firm Performance: Dynamics, Asymmetries, and Alternative Performance Measures," NBER Working Papers 4976, National Bureau of Economic Research, Inc.
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