Interrelations Between Components of Executives' Compensation and Market and Accounting based Performance Measures

Abstract

Alternative forms of executive compensation have different incentive and risk attributes and may respond differently to alternative firm performance measures. Various aspects of the interrelations between compensation components and firm performance measures are considered in an empirical model that relates total compensation to performance through the cash bonus and stock-based shares of total compensation. The model is specified in a manner that permits substitution across types of pay, relaxes restrictive assumptions about the time-series relations between compensation and performance, and accommodates reciprocal relations between pay and performance. Results of estimating the model indicate that both the cash bonus and stock-based shares of executives' total pay vary positively with market and accounting returns. In relation to accounting returns, market returns have a greater influence on stock-based pay than on cash bonus pay. In the determination of compensation awards, market performance is evaluated relative to industry performance and accounting performance is evaluated relative to previous firm performance. Cash bonuses and stock-based awards are substituted for each other and a premium is paid to substitute stock-based pay for cash bonus pay. Compensation changes associated with performance shocks are not persistent and the influence of past accounting performance on expectations of current accounting performance decays over time. The estimation results also support reciprocal relations between pay and performance. Market and accounting returns vary positively with the bonus share and stock-based share of total compensation.