An Analysis of the Relative Importance of Performance Measures in Executive Compensation Contracts
Date Issued
2005
Date
2005
Author(s)
Hung, Yu-shun
DOI
zh-TW
Abstract
The purpose of this paper is to separate stock-based compensation from cash compensation in CEO’s total remuneration contracts. And further, we would like to investigate whether the relative uses of accounting and market performance measures in executive compensation contracts (including cash- and stock-based compensation) would be affected by the properties of the performance measures, personal characteristics, corporate characters, external control mechanisms (e.g. competition in the product market), the industrial character, and the economic cycle.
The result of the paper shows that in the aspect of the properties of the performance measures, if the market performance measure is noisier than the accounting one, the positive relation between accounting performance measure (if positive) and CEO’s cash- and stock-based compensation would relatively more increase, particularly the finding of cash compensation being similar as that of Sloan (1993).
In the aspect of the growth opportunity of the corporate, the finding supports the conjecture of principal-agent-based compensation research, which shows that when firms with significant investment opportunities, current earnings will poorly reflect future period consequences of current managerial actions, exhibiting the noises of the earnings relative to the market performance measures increase. Thus, the accounting performance measure is likely to exhibit low sensitivity, while the market performance measure will have high sensitivity in CEO’s cash-based compensation contracts.
In the aspect of the size of the corporate, the result indicates that when the size of the firm is larger, the positive relation between both performance measures, including accounting and market measures (if positive), and CEO’s stock-based compensation would significantly more decrease. Moreover, the positive relation between the accounting performance measure (if positive) and CEO’s cash-based compensation would relatively more decrease. The possible reason is that the larger the firm’s size, the greater CEO’s responsibility, so as to the consequences of CEO’s actions immeasurable by unique accounting performance measure.
In the aspect of the corporate risk, the result exhibits that when the uncertainty of the environment is higher, CEO’s would relatively more concern about the factor of the risk relative to the incentive. Thus, the firm requires decreasing the link between CEO’s compensation and external performance measures (i.e. the market performance), and replacing with increasing the link between CEO’s compensation and internal performance measures (i.e. the accounting performance).
As for the leverage ratio of the corporate, the result exhibits that when the company has various investors (i.e. debt-holders), they would pay more attention on the profit indicators of the financial statement. Thus, the company requires emphasizing the sensitivity of CEO’s stock-based compensation with the accounting performance measure as the mechanism of the pre-commitment. As to CEO’s cash-based compensation, the finding is consistent with the point of John and John (1993).
In the aspect of CEO’s personal stock holdings of the managed firm, the result exhibits that CEO’s cash-based compensation and his stock holding exist nonlinear relationship, such as curlinear relationship. Furthermore, the impact of CEO’s stock holdings on the sensitivity of his cash- and stock-based compensation with performance measures may have nonlinear relationship.
In the aspect of the relation between CEO and the board, the finding shows that when CEO is the inside director, his cash-based compensation would significantly rise, while his stock-based compensation would not change significantly. As for the sensitivity of compensation and performance, when CEO is the inside director, the positive relation between both performance measures, including accounting and market performances (if positive), and CEO’s cash-based compensation would significantly more decrease. Moreover, the positive relation between the accounting performance measure (if positive) and CEO’s stock-based compensation would significantly more decrease. In addition, when CEO is the board chair, the positive relation between the market performance measure (if positive) and CEO’s cash-based compensation would significantly more decrease, while the positive relation between the accounting performance measure (if positive) and CEO’s cash-based compensation would conversely more increase. Further, the level of his stock-based compensation would significantly fall, but his cash-based compensation would be unchanged, different from the result of CEO being the inside director.
In the aspect of competition in the product market, the result shows that when the product market is more competitive (i.e. value is lower), CEO’s stock-based compensation significantly rise. Moreover, combining the results of the cash- and stock-based compensation contracts shows that when CEO is a risk averter and the product market is more competitive (i.e. the uncertainty is higher), the firm tends to raise the link between CEO’s cash-based compensation and performance measures to replace the link between CEO’s stock-based compensation and performance measures. This results from the risk of stock-based compensation being higher than that of cash-based compensation.
In the aspect of economic cycle, the result shows that during economic downturn (steadily growth), the positive relation between the accounting performance measure (if positive) and CEO’s cash-based compensation would relatively more decrease (increase). As for the industrial character, the finding shows that when the firm belongs to high technology, CEO’s cash- and stock-based compensation would significantly rise. Moreover, when the firm belongs to high technology, the positive relation between the accounting performance measure (if positive) and CEO’s stock-based compensation would significantly more decrease.
Therefore, decisive factors, such as the properties of the performance measures, personal characteristics, corporate characters, competition in the product market, and the economic cycle, having impacts on the relative uses of accounting and market performance measures in executive compensation contracts, indeed would vary with different compensation systems. As a result, while contracting CEO’s compensation, the board of the firm needs wholly to consider those significant factors so as to improve the efficiencies of the governance roles of firm performance measures in CEO compensation.
Subjects
薪酬績效敏感性
公司控制機制
公司特性
corporate control mechanism
executive compensation
corporate character
pay-performance sensitivity
Type
other
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