Real options and earnings-based bonus compensation

Executive Compensation, Corporate Governance and Corporate Performance: A Simultaneous Equation Approach

“…The theory that larger firms are more complex to manage, implies the need for higher quality managers capable of making frequent and significant decisions, but such talented managers are both scarce and highly mobile who can largely be attracted with competitive pay packages (Murphy, ; Sapp, ). Consistent with past studies (Mehran, ; Core et al ., ; Chen et al ., ; Huang et al ., ), our results show that DOWN is associated with significantly lower executive/CEO compensation, suggesting an alignment of executive interests with those of shareholders that minimises managerial expropriation.…”

“…Consistent with past studies (Conyon, ; Murphy, ; Firth et al ., , ; Lin et al ., ; Tian, 2013), our results based on estimating a conventional single equation model indicate that the executive pay and corporate performance elasticity is relatively small, ranging from 0.025 for cash compensation of all executives to 0.098 for total (cash and equity) CEO pay, and implies that the 2002 King Report's (King II) attempt at linking executive pay more closely to performance has not been completely successful. We also find that the executive pay and performance sensitivity is stronger for equity‐based pay than for cash‐based compensation, providing support to the results of previous studies (Jensen and Murphy, ; Conyon and Murphy, ; Conyon and He, , ; Ozkan, ; Huang et al ., ). In addition, the results indicate that CEO pay is more sensitive to performance than those of lower placed executives, consistent with the relatively risky and strategic nature of the CEO post (Ang et al ., ; Sapp, ; Sun et al ., ; Tian, 2013; Bai and Elyasiani, ; Elsila et al ., ).…”

“…Greater independence associated with NEDs potentially puts them in a better position to effectively prevent executives from expropriating shareholder wealth in the form of excessive compensation (Mehran, ; Leung and Horwitz, ; Huang et al ., ). However, Core et al .…”

“…A limitation of these studies is that typically they also do not explicitly address the potential endogeneity problems that may arise from the possible simultaneous use of alternative CG mechanisms and executive pay by firms to contemporaneously minimise agency problems in a simultaneous equation framework. This may explain the noticeably weak executive pay and corporate performance coefficients that have been reported by past studies (Agrawal and Knoeber, ; Beiner et al ., , ; Huang et al ., ).…”

“…A number of reasons may explain the weak findings of past studies. First, because executive pay is just one of the possible corporate governance (CG) mechanisms that companies can employ to minimise agency conflicts (Mehran, 1995;Borisova et al, 2012;Huang et al, 2012), its effectiveness may depend on the simultaneous use of other CG mechanisms (Agrawal and Knoeber, 1996;Chung and Pruitt, 1996;Beiner et al, 2004Beiner et al, , 2006Livne et al, 2013;O'Connor et al, 2013). A major implication of this is that estimating the executive pay and corporate performance sensitivity through the use of single equation modelling techniques can result in endogenous associations (Core et al, 1999;Larcker and Rusticus, 2010;Gil-Alana et al, 2011;Connelly et al, 2012;Bai and Elyasiani, 2013).…”