An Analysis of the Relative Importance of Performance Measures in Top Executive Stock-Based Compensation Contract

Abstract

The purpose of this paper is to investigate whether the relative importance of accounting and market performance measures in executive stock-based compensation contracts would be affected by corporate characteristics, such as the growth opportunity, size, risk and financial leverage of the corporation. Our results show that the President's stock-based compensation reacts differently to accounting and market performance measures when considering corporate characteristics. We also find that the change-form and level-form of model specification may have different implications. For firms with higher growth opportunity and larger size, the accounting performance measure would have lower sensitivity in the level of the President's stock-based compensation. Further, for firms with a more uncertain environment and higher financial leverage, the accounting performance measure would have higher sensitivity in the level of the President's stock-based compensation. Conversely, for firms with larger size and higher uncertainty, market performance measure would have lower sensitivity in the level of the President's stock-based compensation. These findings indicate that corporations would substitute the internal accounting performance measure for external market performance measure to evaluate the President's actions when they face greater uncertainty of the external environment and debtholders.