Wealth Creation and Managerial Pay: MVA and EVA as Determinants of Executive Compensation

The design of incentive compatible executive-compensation policies is a crucial element for firms that seek a competitive advantage in an effort to maximize owner wealth. In this paper, we examine the relationship between executive compensation and measures of firm performance that capture the economic profit earned by the firm, namely, EVA and MVA. We test the hypothesis that after controlling for risk, these measures are more effective measures of wealth creation and hence executive compensation. We find that firm size and risk are related to the pay of top executives. We also find evidence that top manager pay is related to market value added to the firm during the year. By grouping firms into cohorts based on polar performance (high/low) for each performance measure, we are able to provide additional insights about executive compensation. By controlling for the relative level of performance, executive compensation plans reward top managers for their relative level of contribution to the wealth of owners. Finally, we assess whether top manager pay is an incentive for future performance or reward for past behavior. Our evidence suggests that top managers are incented to increase the EVA of the firm but are also rewarded for past additions the market value as measured by MVA. Wealth Creation and Managerial Pay: MVA and EVA as Determinants of Executive Compensation