Firm Performance and CEO Compensation: CEO Pay Slice vs Pay-Performance Sensitivity

Abstract

I study the relationship between CEO incentive compensation and firm performance in the presence of CEO dominance to examine how incentive compensation improves firm performance by reducing agency conflicts between shareholders and managers. I estimate pay-performance sensitivity (PPS) as a measure of CEO incentive compensation and the CEO pay slice (CPS) as a measure of CEO dominance. Controlling for standard control variables, I conduct multiple OLS regressions and find that at the high level of CPS, PPS improves firm performance, but at the low level of CPS, impact of PPS diminishes. This shows that determining stand-alone associations of PPS or CPS to firm value—a popular practice in the literature—might not be adequate because of an unexplored interaction effect between executive incentive and executive dominance. To address the potential endogeneity issues, I conduct robustness check by employing instrumental variables with a two-stage least square (2SLS) estimation procedure. As an additional robustness check, I account for the year effect and confirm that the results still stand to the same level of significance.