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CEO Pay and Firm Performance: Dynamics, Asymmetries, and Alternative Performance Measures

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  • Paul L. Joskow
  • Nancy L. Rose

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.

Suggested Citation

  • 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.
  • Handle: RePEc:nbr:nberwo:4976 Note: IO
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    File URL: http://www.nber.org/papers/w4976.pdf
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    References listed on IDEAS

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    1. Barro, Jason R & Barro, Robert J, 1990. "Pay, Performance, and Turnover of Bank CEOs," Journal of Labor Economics, University of Chicago Press, vol. 8(4), pages 448-481, October.
    2. Nancy L. Rose & Andrea Shepard, 1997. "Firm Diversification and CEO Compensation: Managerial Ability or Executive Entrenchment?," RAND Journal of Economics, The RAND Corporation, vol. 28(3), pages 489-514, Autumn.
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    6. Hubbard, R. Glenn & Palia, Darius, 1995. "Executive pay and performance Evidence from the U.S. banking industry," Journal of Financial Economics, Elsevier, vol. 39(1), pages 105-130, September.
    7. repec:bin:bpeajo:v:24:y:1993:i:1993-1m:p:1-72 is not listed on IDEAS
    8. Gibbons, Robert & Murphy, Kevin J, 1992. "Optimal Incentive Contracts in the Presence of Career Concerns: Theory and Evidence," Journal of Political Economy, University of Chicago Press, vol. 100(3), pages 468-505, June.
    9. Jensen, Michael C & Murphy, Kevin J, 1990. "Performance Pay and Top-Management Incentives," Journal of Political Economy, University of Chicago Press, vol. 98(2), pages 225-264, April.
    10. Robert Gibbons & Kevin J. Murphy, 1990. "Relative Performance Evaluation for Chief Executive Officers," ILR Review, Cornell University, ILR School, vol. 43(3), pages 30, April.
    11. Steven N. Kaplan, 1992. "Top Executive Rewards and Firm Performance: A Comparison of Japan and the U.S," NBER Working Papers 4065, National Bureau of Economic Research, Inc.
    12. Bengt Holmstrom, 1979. "Moral Hazard and Observability," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 74-91, Spring.
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    Citations

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    Cited by:

    1. Giorgio Canarella & Mahmoud M. Nourayi, 2008. "Executive compensation and firm performance: adjustment dynamics, non-linearity and asymmetry," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 29(4), pages 293-315.
    2. Spagnolo, Giancarlo, 1999. "On Interdependent Supergames: Multimarket Contact, Concavity, and Collusion," Journal of Economic Theory, Elsevier, vol. 89(1), pages 127-139, November.
    3. Clara Graziano & Laura Rondi, 2015. "Market Competition or Family Ties: Which Prevails on Italian CEOs Pay?," CESifo Working Paper Series 5398, CESifo Group Munich.
    4. Carola Frydman & Dirk Jenter, 2010. "CEO Compensation," Annual Review of Financial Economics, Annual Reviews, vol. 2(1), pages 75-102, December.
    5. Carola Frydman & Raven E. Saks, 2010. "Executive Compensation: A New View from a Long-Term Perspective, 1936--2005," Review of Financial Studies, Society for Financial Studies, vol. 23(5), pages 2099-2138.
    6. Yusuf Mohammed Nulla & Dimitris Nikolaou Koumparoulis, 2013. "CEO Compensation System in Large Canadian Financial Institutions," International Journal of Economics & Business Administration (IJEBA), International Journal of Economics & Business Administration (IJEBA), vol. 0(1), pages 137-155.
    7. Hideaki Sakawa & Naoki Watanabel, 2006. "The Relationship between Managerial Compensation and Business Performance in Japan: New Evidence using Micro Data," Discussion Papers in Economics and Business 06-29, Osaka University, Graduate School of Economics and Osaka School of International Public Policy (OSIPP).
    8. Grant, Simon & King, Stephen & Polak, Ben, 1996. " Information Externalities, Share-Price Based Incentives and Managerial Behaviour," Journal of Economic Surveys, Wiley Blackwell, vol. 10(1), pages 1-21, March.
    9. Marianne Bertrand & Sendhil Mullainathan, 1998. "Executive Compensation and Incentives: The Impact of Takeover Legislation," NBER Working Papers 6830, National Bureau of Economic Research, Inc.
    10. Suchan Chae & Paul Heidhues, 2004. "Buyers' Alliances for Bargaining Power," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 13(4), pages 731-754, December.
    11. Spagnolo, Giancarlo, 2005. "Managerial incentives and collusive behavior," European Economic Review, Elsevier, vol. 49(6), pages 1501-1523, August.
    12. Gregory E. Sierra & Eli Talmor & James S. Wallace, 2004. "A unified analysis of executive pay: the case of the banking industry," Supervisory Policy Analysis Working Papers 2004-02, Federal Reserve Bank of St. Louis.
    13. Spagnolo, Giancarlo, 1996. "Multimarket Contact, Concavity, and Collusion: on Extremal Equilibria of Interdependent Supergames," SSE/EFI Working Paper Series in Economics and Finance 104, Stockholm School of Economics, revised 30 Nov 1998.
    14. Brunello, Giorgio & Graziano, Clara & Parigi, Bruno, 2001. "Executive compensation and firm performance in Italy," International Journal of Industrial Organization, Elsevier, vol. 19(1-2), pages 133-161, January.
    15. George P. Baker & Brian J. Hall, 1998. "CEO Incentives and Firm Size," NBER Working Papers 6868, National Bureau of Economic Research, Inc.
    16. Brian J. Hall & Jeffrey B. Liebman, 1998. "Are CEOs Really Paid Like Bureaucrats?," The Quarterly Journal of Economics, Oxford University Press, vol. 113(3), pages 653-691.
    17. Brian J. Hall, 1998. "The Pay to Performance Incentives of Executive Stock Options," NBER Working Papers 6674, National Bureau of Economic Research, Inc.
    18. Shota Otomasa & Atsushi Shiiba & Akinobu Shuto, 2015. "Management Earnings Forecasts as a Performance Target in Executive Compensation Contracts," CARF F-Series CARF-F-368, Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo.
    19. Sarowar Hossain & Gary S. Monroe, 2015. "Chief Financial Officers’ Short- and Long-term Incentive-based Compensation and Earnings Management," Australian Accounting Review, CPA Australia, vol. 25(3), pages 279-291, September.
    20. Mäkinen, Mikko, . "Essays on Stock Option Schemes and CEO Compensation," ETLA A, The Research Institute of the Finnish Economy, number 42.
    21. Matthew Lilling, 2006. "The Link Between CEO Compensation and Firm Performance: Does Simultaneity Matter?," Atlantic Economic Journal, Springer;International Atlantic Economic Society, vol. 34(1), pages 101-114, March.
    22. Graßhoff, Ulrike & Schwalbach, Joachim, 1997. "Corporate restructuring, downsizing and managerial compensation," SFB 373 Discussion Papers 1998,35, Humboldt University of Berlin, Interdisciplinary Research Project 373: Quantification and Simulation of Economic Processes.
    23. Rajiv D. Banker & Danlu Bu & Mihir N. Mehta, 2016. "Pay Gap and Performance in China," Abacus, Accounting Foundation, University of Sydney, vol. 52(3), pages 501-531, September.
    24. repec:eee:labchp:v:3:y:1999:i:pb:p:2485-2563 is not listed on IDEAS
    25. Renneboog, Luc, 2000. "Ownership, managerial control and the governance of companies listed on the Brussels stock exchange," Journal of Banking & Finance, Elsevier, vol. 24(12), pages 1959-1995, December.

    More about this item

    JEL classification:

    • G3 - Financial Economics - - Corporate Finance and Governance
    • J3 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs

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