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Firm Performance and Executive Compensation in the Savings and Loan Industry

  • Benjamin E. Hermalin

    (University of California at Berkeley)

  • Nancy E. Wallace

    (University of California at Berkeley)

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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File URL: http://128.118.178.162/eps/fin/papers/9710/9710006.pdf
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Paper provided by EconWPA in its series Finance with number 9710006.

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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://128.118.178.162

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  1. Bengt Holmstrom, 1979. "Moral Hazard and Observability," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 74-91, Spring.
  2. Jensen, Michael C, 1986. "Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers," American Economic Review, American Economic Association, vol. 76(2), pages 323-29, May.
  3. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-70, May.
  4. Michael L. Katz, 1991. "Game-Playing Agents: Unobservable Contracts as Precommitments," RAND Journal of Economics, The RAND Corporation, vol. 22(3), pages 307-328, Autumn.
  5. Haubrich, Joseph G, 1994. "Risk Aversion, Performance Pay, and the Principal-Agent Problem," Journal of Political Economy, University of Chicago Press, vol. 102(2), pages 258-76, April.
  6. Jensen, M.C. & Murphy, K.J., 1988. "Performance Pay And Top Management Incentives," Papers 88-04, Rochester, Business - Managerial Economics Research Center.
  7. Benjamin E. Hermalin & Michael S. Weisbach, 1996. "Endogenously Chosen Boards of Directors and Their Monitoring of the CEO," Working Papers _004, University of California at Berkeley, Haas School of Business.
  8. Grossman, Sanford J & Hart, Oliver D, 1983. "An Analysis of the Principal-Agent Problem," Econometrica, Econometric Society, vol. 51(1), pages 7-45, January.
  9. Weisbach, Michael S., 1988. "Outside directors and CEO turnover," Journal of Financial Economics, Elsevier, vol. 20(1-2), pages 431-460, January.
  10. Varian, Hal R, 1984. "The Nonparametric Approach to Production Analysis," Econometrica, Econometric Society, vol. 52(3), pages 579-97, May.
  11. Robert Gibbons, 1996. "Incentives and Careers in Organizations," NBER Working Papers 5705, National Bureau of Economic Research, Inc.
  12. Garen, John E, 1994. "Executive Compensation and Principal-Agent Theory," Journal of Political Economy, University of Chicago Press, vol. 102(6), pages 1175-99, December.
  13. Amemiya, Takeshi, 1978. "A Note on a Random Coefficients Model," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 19(3), pages 793-96, October.
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