Regulatory and Life Cycle Influences on Managerial Incentives

Abstract

An important controversy persists in economics concerning the appropriateness of profit maximization as opposed to various competing nontraditional theories of the firm [13]. Of particular interest has been the comparative relevance of the sales maximization hypothesis suggested by Baumol [4] and others. A typical methodology employed to empirically analyze the profit versus sales maximization issue has been to question whether the financial rewards of top executives are more strongly influenced by corporate profit or sales performance. It is implicitly assumed that the firm has a well-defined set of organizational goals and that the structure of executive compensation is designed to provide executives with a consistent set of incentives. Therefore, should profit performance constitute a significant determinant of executive compensation, support for the profit maximization hypothesis would be gained. On the other hand, if executive compensation is closely related to firm sales, then the nontraditional sales maximization hypothesis would be supported. In an early empirical analysis of the issue McGuire, Chiu and Elbing [14] found that sales and compensation were more highly correlated than were profits and compensation and, therefore, that the Baumol hypothesis seemed most relevant. Lewellen and Huntsman [12] pointed out, however, that McGuire, et al., had neglected to consider the deferred and contingent (stock options, etc.) elements of executive compensation and in so doing had perhaps biased their analysis against the profit maximization hypothesis. By correctly considering the impact of corporate performance on the total compensation of top corporate executives, Lewellen and Huntsman found strong support for the profit maximization hypothesis, and no support for sales maximization. In fact, so convincing were the Lewellen and Huntsman results that they seemed to resolve the managerial motivation issue in favor of the traditional profit maximization model. More recent empirical analyses, however, have tended to suggest that the issue is far from resolved. Baker [3], Boyes and Schlagenhauf [5], and Ciscel and Carroll [6] have all