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The Link Between CEO Compensation and Firm Performance: Does Simultaneity Matter?

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  • Matthew Lilling

Abstract

In order to combat the principle-agent problem, directors of public companies use incentive-based contracts to align the interests of CEOs and shareholders. Some studies suggest that these contracts are an inefficient use of resources, and that they do not motivate CEOs to do what is best for the firm. In this study, the author estimates a regression to find the relationship between CEO Compensation and market value of a firm. In order to address persistence, endogeneity and firm-specific effects the author uses the first-differenced and system GMM regression techniques first used by [Arellano, M.; Bover, O. “Another Look at the Instrumental-Variable Estimation of Error-Component Models,” Journal of Econometrics, 68, 1995, pp. 29–51] and [Blundell, R. W.; Bonds, S. R. “Initial Conditions and Moment Restrictions in Dynamic Panel Data Models,” Journal of Econometrics, 87, 1998, pp. 115–43; Blundell, R. W.; Bond, S. R., Windmeijer, F. “Estimation in Dynamic Panel Data Models: Improving on the Performance of the Standard GMM Estimators,” Institute for Fiscal Studies Working Paper W00/12, London, England, 2000]. These regressions report a positive relationship between CEO compensation and market value of a firm. This study concludes that incentive based contracts are effective, due to the positive pay-to-performance link, when controlling for simultaneity. Copyright International Atlantic Economic Society 2006

Suggested Citation

  • Matthew Lilling, 2006. "The Link Between CEO Compensation and Firm Performance: Does Simultaneity Matter?," Atlantic Economic Journal, Springer;International Atlantic Economic Society, vol. 34(1), pages 101-114, March.
    • Handle: RePEc:kap:atlecj:v:34:y:2006:i:1:p:101-114
    DOI: 10.1007/s11293-006-6132-8
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    References listed on IDEAS

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    2. Giorgio Canarella & Mahmoud M. Nourayi, 2008. "Executive compensation and firm performance: adjustment dynamics, non-linearity and asymmetry," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 29(4), pages 293-315.
    3. Elena Merino & Montserrat Manzaneque & Alba Maria Priego, 2013. "“Board independence” and compensation structure of directors," Copernican Journal of Finance & Accounting, Uniwersytet Mikolaja Kopernika, vol. 2(2), pages 125-152.

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    JEL classification:

    • J3 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs

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