To what extent does executive pay influence company performance?
There has been widespread controversy in recent years about the amount of compensation CEO’s receive. CEO’s financial compensation packages were largely structured to incentivize risk taking in order to increase shareholder wealth (“Restraints on Executive Pay”, 2009). Yet, the 2008 financial crisis was mostly characterized by declining levels of company performance largely due to the increase of risk afforded to CEO’s by the attractiveness of lucrative executive incentives to perform. This essay argues that executive pay and its influence on company performance is both controversial and complex and concludes that executive pay has minimal influence on company performance and, when it does have influence, it tends to be negative. It is widely believed that companies and their shareholders suffer from poor performance unless the importance of incentives for executives – most notably through monetary and stock compensation – is realized (Jensen and Murphy 1990). The notion that the level and performance sensitivity of pay affects the quality of managers an organization can attract in a competitive labor market for executives seems, on the surface, uncontroversial. However, whether compensation policy is truly “one of the most important factors in an organization’s success” (p.139), as Jensen and Murphy (1990) assert needs further examination A series of empirical studies from a variety of industry, national, and time settings present evidence contrary to the conventional belief in the effectiveness of performance-related pay. In a paper exploring the effect of executive compensation policy on the profitability of companies in Japan in 1993-1995, Kubo (1995) found very weak linkage between the pay-performance sensitivity of a company’s compensation policy and its return on capital, prompting the researcher to conclude that “firms with highly geared incentive packages are actually less likely to...
References: Bebchuk, L. A., & Fried, J. M. (2006). Pay without performance: The unfulfilled promise of executive compensation. Cambridge, MA: Harvard University Press.
Cooper, M. J., Gulen, H., & Rau, P. R. (2009). Performance for pay? The relationship between CEO incentive compensation and future stock price performance. Unpublished working paper.
Fong, E. A., Misangyi, V. F., & Tosi, H. L. (2010). The effect of CEO pay deviations on CEO withdrawal, firm size, and firm profits. Strategic Management Journal, 31(6), 629-651.
Jensen, M., & Murphy, K. (1990). CEO incentives – it 's not how much you pay, but how. Harvard Business Review, 68(3), 138-153.
Kubo, K. (2005). Executive compensation policy and company performance in Japan. Corporate Governance: An International Review, 13(3), 429-436.
Restraints on executive pay. Attacking the corporate gravy train. (2009, May). Retrieved from http://www.economist.com/node/13726705
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