Abstract
We examine the relationship between executive compensation and technical efficiency. We highlight heterogeneity in this relationship, identify opportunities for within-sector efficiency gains, and the channels through which such gains occur. Previous research mainly focuses on excessive executive compensation that does not reflect firm performance. We develop unique measures for executive overcompensation and undercompensation, and account for endogeniety. Using firm-level data for the Indian chemical, textile, and pharmaceutical sectors during 2004–2015, we conclude that the median firm overcompensates and large firms undercompensate their executives. Overcompensation decreases firms’ profits as increased executive costs outweigh the benefits of efficiency gains. Firms in the top 10% in terms of sales in their industry undercompensate their executives and experience a median increase in profits when executive compensation increases. This new insight has important implications for executive compensation strategies: for the subset of large firms that undercompensate, increased executive compensation is a channel for improving profitability.
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