The Impact of Executive Compensation on Firm Performance

The Impact of Executive Compensation on Firm Performance

Abstract:

We find that the Board of Directors measures and the ownership structure explain a significant amount of variation in the cross head of executive compensation, after controlling for standard economic determinants of pay. Moreover, the signs of the coefficient on company structure and ownership variables suggest that CEOs earn more compensation when governance structures are less effective. We find that also predicted component of compensation as a result of these characteristics of the board and ownership structure has a statistically significant negative relationship with subsequent firm operating and stock return performance. Overall, our results suggest that firms with weaker governance structures have greater agency problems; the CEOs of firms with greater agency problems get larger compensation; and that firms with greater agency problems performing worse.

Introduction:

Executive compensation is an award given to the executive of the firm on their performance this award is composed of financial or non-financial award. The basic purpose of this discussion is to tell how executive compensation can lead to better firm performance this can be done by increasing in the salary of CEO or employees of the firm. Compensation can also give to the organization shareholders by providing them incentives or by giving them more shares. Executive compensation decided by the board of directors then according to the firm performance they make increment. Compensation always has direct relationship with the firm performance. In executive compensation there always have some sort of association between the level of CEO compensation and the quality firm corporate governance.

We do executive compensation because of board of directors and ownership has substantic cross sectional association they vary on each other and this all lead to firm performance (Shulze et al., 2001). Executive compensation can be done by giving the flat salary or somehow satisfactory incentives may pursue goals and maximizing the firm performance at potentially very large cost of the shareholders. An efficient compensation scheme must provide CEOs with better

benefits to take risks while insulating them at least partially against potential bad results.

While this is commonly theorized as an attractive approach to aligning shareholder and executive

interests, it does not appear to have been empirically tested. Executive compensation can just be tested by firm performance how they are moving towards their goals. Firm performance and executive compensation are positively correlated with each other the CEO and director are known as the big guns of the companies if they work in positive direction then firm performance can be high and towards profitability.

In 1990’s CEO compensation can be replace by salary but now a day’s stock option put for them as a bonus/incentives. CEO compensation and shareholder also have a positive relation between them as CEO encourage the shareholder to purchase more shares for the companies at market value so that ore share sell and profitability for the organization get increased  (; Gopalakrishman, 2000). Corporate governance and firm performance show good governance as there impact on economic value, higher productivity and lower risk. During all this company the return on equity get also increased as all these good cooperate governance have direct impact on return on equity. Company sell mores shares more shareholder get those shares higher will the return on equity. Return on asset and return on equity both these equities get increased as proper CEO or Executive compensation took place and their impact on firm performance will led the company to higher profitability (Miller, Wiseman, & Gomaz-Mejia, 2013). Return on asset is basically an indicator how profitability of a company is very relative to its total assets a company have.  ROA gives an idea how effective management is using its assets to generate more profit for the company.

The main objective of this research is to find that whether profitability ratios like ROA and ROE affect the performance of the firm or not. And what their impact on executive compensation. In this research the qualitative data have been used to discuss this executive compensation and firm performance aspects more widely and clearly. Now in every organization whether it is small or large organization firm performance impact plays a very vital role like good corporate governance is part of all the organizations and the compensation can be judge by how much shares the shareholder of the company have what percentage of dividend shareholder is receiving, and what impact of ROE, ROA and salary on the CEO performance.

Literature Review:

The study of executive compensation and its impact on firm performance seen in the context of relationship between the executive and the firm overall performance. Now a days in every organization whether it is small or large organization the executive compensation is more highlighted element what basic pay, bonuses, shares/stock options, and retirement plans along with other benefits are being included in executive compensation. The paradigm comes here between the separation of management and ownership of the companies. Somehow conflict can also occur here, as executive compensation is very much align to the interest of executive shareholders which lead towards the significant deviations.

The concept of executive compensation first derived from the United States of America in 1980. This concept basically relates to the average worker wage in the United States and compare it with the other countries wage system. As we all know that the most important element of Corporate Governance is Executive pay and this can be determine by the Board of directors (BOD).

Now if we overview the International contribution that how researchers contribute towards the executive compensation and its impact on firm performance. Masson (1971) conducted a study in which he determined the relationship between CEO reward, the net sales and the stock-performance of the firm. According to Masson’s findings, there is no relationship, neither positive nor negative, between executive compensation and the sales of the firm. However, it was found the CEO’s, whose financial returns were more closely aligned with the stock-holders interests, performed better in the stock market. Murphy and Jensen (1990) carried out a statistical study, in which they incorporated data on thousands of CEO’s for a period of five years. Their sample data consisted of 2505 CEO’s financial benefits (annual increments / pays ) of 1400 public sector firm’s for the period of 14 years i.e. 1974-1988.  They also gathered data for CEO’s of 430 public sector companies on stock options and stockownership. In addition to this, Murphy and Jensen also gathered CEO’s reward data for 700 plus public owned companies. They determined a weak association between CEO compensation and firm performance in terms of stock holder’s wealth. Kato and Kubo (2003) came up with the first panel data research on the sensitivity of performance of CEO compensation in Japan.