CEO Compensation and a Company's Performance Term Paper

Excerpt from Term Paper :

CEO's salary, bonus, and long-term compensation with respect to various organizational, financial and CEO factors such as corporate reputation, growth in employees, company size, and return on equity, CEO tenure and CEO stock ownership. In relation to the general performance of the organization

This paper utilizes the various measurement of chief executive compensation as exploited by the various detailed pieces of literature and employed as the dependent variable in a model based on multiple regression theory. It explores the extent to which the CEO's compensation package affects the overall performance of the whole firm or corporation for which he or she works for.

The purpose of this research is to determine the extent to which the CEO's remuneration a large corporation such as Coca Cola has on the general performance of the organization.


The CEO's compensation has for a long time been source of attention from various groups in both the general society and the corporate circles. The investors who are involved in the funding of the various organizations and firms usually want to ensure that the hired CEO's remuneration and its related incentives are having a direct and positive influence on the general performance of the firm in question.

The lack of proper performance by a certain CEO whose pay check is fat is often met with excessive opposition from the media, the investors and the general public. The global reactions to misappropriation of funds due to certain leadership or rather governance styles have therefore necessitated various academic debates in respect to the actual determinants of the CEO's pay and what its overall effect on the performance of the corporation should be. Most literature however, point out clearly that the most important parameter that influence the size of the CEO's compensation are the corporation's size. The compensation-performance correlation is therefore a very fundamental issue to be studied and therefore effected in order to ensure the due profitability and continuity of the various global corporations. Previous studies however, do suggest that a very weak relationship do exists between the CEOs pay and the level of performance of any given corporation.

It has been observed in the recent past that high level of corporate governance is necessary in order to ensure that the CEO's compensation truly matches the performance of the corporation. This has mostly been fuelled by the recently observed cases of leadership failures that were unfortunately coupled with very high CEO's compensation levels. The best examples are the various scandals that rocked both the U.S. And the UK corporations. Specific examples of corporate failure that were however marked with very high CEO's pay are the Maxwell Corporation, Enron and Tyco (Girma etal. 2007:65).The failures of these mega corporations were all linked to very elevated CEO's compensation (Matsumura and Shin, 2005).

Data Collection and Methodology

The research technique that is to be adopted is based on the longitudinal panel analysis of sample size of 100 firms from 2000 to 2004.This technique is however, rarely utilized in the context of socially centered research as postulated by (Ryman and Bell, 2003).The technique of data collection for this study is to be mainly through archival research. It is worthwhile to note that there is a big gap that is placed between the researcher and the actual research reality. The researcher shall mainly apply the real CEO's salary statistics against the actual company performance data sets. All these two data sources are far much withdraws from the researcher. We shall stick mainly to the archival technique of data collection due to its permanency attribute. This method also has the merit of allowing the future researchers to apply the same data sets in the analysis of other phenomena or various other improvements in the already existing research projects. The other source of data for this analysis is the financial databases that are readily available through hand collection from various yearly remuneration reports.

The datasets for the two major parameters are then analyzed by utilizing the first-differenced and then subsequently the system Generalized Method of Moments (GMM) regression techniques as postulated by Arellano and Bond [1991] The problem however of the unobserved corporation-specific effects is however taken care of by making use of a corporation-differenced details, while the existence of the lagged performance and better selection of tools takes care of the issue of persistence and even the significant endogeneity.

Several equations are then formulated that tally with the various drawn hypothesis and then dummy variable introduced in the necessary parts of these equations so as to take care of even the slightest of the determinates and errors that may be existent in the analysis.

Literature review

CEO s compensation in this research proposal is taken to be a way of determining a CEOs salary. CEOs compensation in this case is the initiative company owner's tries so much to compensate their CEOs fairly in order for them to continue with running the companies without any strains and to still look in the best interest of the company. This is owed to the fact that management is "not always constrained to act with the owner's welfare in mind," (Lewellen and Huntsman, 1970) this always because the owner is not involved with running the company directly but through the manager who should be well compensated. CEOs compensation becomes a problem because both owners of the company and the CEO works hard to achieve the best for their company thus the owners should look in ways such as giving the managers a basic salary and compensate them more when the company get more profits. This can be through commissions or even performance-based bonus which are all through incentive-based contracts. The level of managerial effort will depend on an executive's incentive contact, (Murphy 1986)

CEOs compensation has grown gradually over the last 50 years and covers disciplines such as economics, Law, accounting and organizational structure, (Murphy 1999) financial economist such as Jensen and Murphy (1990), have studied the relationship between CEOs compensation and company performance.

Financial economists have also investigated the effects of variables such as the decisions of the directors, capital base of the company, dividend policies mergers, diversification (Murphy, 1999: 2) on CEOs compensation. CEOs compensation is thought to be the most effective way of addressing the company's problem of who owns it and who controls it, (Jensen and Mackling 1979).

Many owners might find this inefficiency troubling. Hall and Liebman (1997) recreated Jensen and Murphy's experiment and found there was a greater relationship between CEO pay and company performance than Jensen and Murphy (1990) thought. This was because Jensen and Murphy (1990) used data from 1969-1983, which predates the "explosion of the use of stock options issuance" that began in the 1980s. Hall and Liebman use expanded data covering the 1980s and some of the 1990s. Between 1980 and 1994, the median value of stock option grants ranges from zero dollars to $325,000. In 1980, 30% of CEOs received options, while in 1994, this figure increased to 70% (Hall and Liebman, 1997). Thus according to this study we assume that stock options are a very important part of the incentive-based contract.

This proposal then tires to evaluate the correlation between CEOs compensation and it effects on a company's performance which were guided by two hypotheses. The first one holds that the CEOs compensations is determined by his past performance, while the second holds that incentives are not important and executive productivity depends on "managerial ability which is initially unknown, but revealed over time, (Murphy 1989).

CEOs compensation affects the company's performance and should be an initiative that is to be taken by both the owners' and those who manage the company. This is because when there is a good compensation package for the manager the he would strive to unleash his potentials to the fullest enabling the company perform better on the other hand the owner should strive to have a good capital base and dividend policies among other that would enable smooth running of the company.

The researcher earlier have tried to evaluate this phenomenon using various theoretical framework to evaluate above such as neoclassical theory, managerial theory, relative performance evaluation theory, principal agent theory, human capital theory, social comparison theory, managerial power theory, information processing theory and tournament theory.

A vast number of researchers who tries to evaluate CEOs pay and performance use the principal agent theory as the basis of their research. On the other hand agency framework is used as an effective way of aligning CEOs interests more closely to those of the owners by enabling a clear reward system that acknowledges the reward system.

The objective of this study is to examine the relationship by controlling for persistency and simultaneity. When doing empirical work with panel data, there are two factors one must take into consideration. First, it is likely that CEO compensation and firm performance are correlated with the current realization of the unobserved firm-specific effects (Marschak and Andrews, 1944). There are additional factors, such as effectiveness of…

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