The Impact of Incentives on the CEO Compensation and Firm Performance

Abstract

A significant component of a management control system is the incentive mechanism and motivational underpinning of compensation contracts. Most executives are rewarded in the form of cash and company stock. The majority of public companies offers stock options or restricted stock in order to assure congruity of manager's welfare and owners' wealth maximization objectives. Our data indicate that over 75 percent of our observations include bonus pay to the CEOs and even a larger percentage, about 97 percent, have stock option grants. This study analyzes the impact of various incentives used in CEO compensation contracts in conjunction with firm's performance measures. We examined the significance of explanatory power of variables such as size, performance, and change in the number of employees in the compensation models. Our results indicate market-based performance measure is significant as an explanatory variable for both cash compensation (CC) and total compensation (TC) of CEOs. On the other hand, accounting-based performance measure is significant as an explanatory variable only for cash compensation. The regressions results indicate that increases in the number of employees influence both cash and total compensation positively. However, only cash compensation response appears to be statistically significant. Our results indicate significant differences in the means of compensation and performance measures, both market-based and accounting-based, associated with existence of bonus incentives. We also find that means of compensation and stock prices are significantly larger for CEOs who enjoy stock option incentives. However, the accounting-based measure of performance did not appear to be significantly influenced as a result of stock-based rewards.