Re-examination of connectivity between CEO compensation and tenure at the helm and firm performance

Abstract

This paper presents empirical evidence related to a CEO’s tenure, compensation, and performance. It reviews some generally accepted assumptions that have driven the rationale for CEO compensation packages, performance, and monitoring by the boards in charge of corporate governance. The empirical results of this paper provide only partial support for the underpinning basis of many of the compensation and corporate governance packages in today’s corporate world. The paper uses data that was available to management and shareholders prior to the onset of the asset bubble that imploded during 2007-2009 period, and shows that there was already by then room for concern. The empirical findings presented here suggest that there is a mild positive relation between improvement in firm performance and the compensation package but even this is more evident in firms where the CEO service has a longer tenure compared to firms with a shorter tenure serving CEO. The results also support the findings from earlier studies that it is desirable to have an incentive scheme contingent on future returns, not only on the short time horizon. The findings presented here also confirm that CEOs who have passed the “early probation” test of time and skills and gained time to develop experience to lead the firm and its business have a stronger relationship between compensation and firm performance. However, the relatively low statistical relationships between compensation and firm performance for the whole sample overall leave room for concerns about the limited extent of their effectiveness. This paper also raises indirectly also concerns that the theoretical motivations of some compensation packages and the actual practices in the real world were not well aligned despite the large number of studies and efforts aimed at improving the relationship between CEO compensation and firm performance.