Investigating the associations between executive compensation and firm performance: Agency theory or tournament theory
Abstract
Purpose
While there have been extensive empirical investigations of pay-performance sensitivity, the perspective of performance-pay has received less attention to date. While executive compensation is sensitive to firm performance, firm performance is also likely to be affected by executive compensation. Adopting multiple theoretical perspectives, the purpose of this paper is to examine whether executive compensation has a greater influence on firm performance or whether the latter has a greater influence on compensation.
Design/methodology/approach
Using data from a five-year period (2010-2014) for Financial Times and Stock Exchange 350 companies, the authors employ a set of simultaneous equation modelling to jointly investigate, after accounting for endogeneity problem, the mutual association of executive compensation and firm performance by employing four control variables (board size, non-executive directors, leverage and boardroom ownership).
Findings
The authors find strong evidence for the greater influence of executive compensation on firm performance than the pay-performance framework. This finding supports the tournament theory compared with the agency perspective.
Research limitations/implications
Inevitably, there are limitations in a wide-ranging study of this nature that could be addressed in future research. As any empirical study utilising company data, there may be concerns to the effect of survivorship bias and the manner in which companies have reorganised, if there is any, themselves during the period under examination. There are also issues as to missing data, some measures relating to both executive compensation and corporate governance are not provided by the BoardEx database.
Practical implications
The study results provide evidence that using the tournament perspective by remuneration committees as a guide for determining executive compensation helps in achieving better performance. This helps in developing appropriate mechanisms for setting executive remuneration.
Originality/value
This paper combines an empirical investigation of the frameworks of pay-performance and performance-pay and develops a system of six simultaneous equations to examine the associations between executive compensation and firm performance.
Keywords
Citation
Elsayed, N. and Elbardan, H. (2018), "Investigating the associations between executive compensation and firm performance: Agency theory or tournament theory", Journal of Applied Accounting Research, Vol. 19 No. 2, pp. 245-270. https://doi.org/10.1108/JAAR-03-2015-0027
Publisher
:Emerald Publishing Limited
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