executive compensation and firm performance: shareholders perspective

this study addresses executive compensation from shareholders perspective by empirically examining the effects of chief executive officer (ceo) compensation on firm performance subsequent to the year of compensation. three factors of ceo compensation are examined, size, total annual compensation; form percentage of total compensation comprised of cash, cash bonuses and stock; and sensitivity. the degree of short- term and long- term risk- sharing imposed by the compensation contract. this study employs the basic agent- principal model to develop testable hypotheses and a sample of 24 firm for the empirical tests. this study employs a unique approach by considering ceo compensation as an investment by shareholders in executive decisions that affect future firm performance. this approach provides a better understanding of the relationship between ceo compensation and shareholders wealth. in contrast, the extensive prior literature has regarded ceo compensation as a reward system for current and past firm performance. this empirical findings of this study suggest the following relationship between ceo compensation and shareholders wealth: (a) the direct cost of ceo compensation is “ material” in the most extreme cases. (b) large annul cash bonuses in one year are following by significantly positive relative accounting returns in subsequent years. (c) larger stock ownership by ceo’s is not associated with relative accounting returns in current and subsequent years. this study contributes to the existing executive compensation literature by empirically demonstrating that the various compensation and personal stock ownership by ceo’s may have very different incentive effects on shareholders wealth. this study suggest that the literature’s underlying assumption regarding the effects of annual bonuses and personal stock ownership are questionable.