A Correlation Between Firm Performance and Executive Compensation

2. Literature Review

ABSTRACT

Before we started to review several scientific articles and compare their assumptions with our data on this issue which is investigating whether company performance has an impact on executive compensation, especially in crisis situations like occurred in 2008 H1. To get a broader view about the overall structure level of the executive compensation, the paper compares European and American global players and highlights the differences among them to reveal whether there are cultural differences H2. In addition, the paper provides an overview about the recent development of firm performance and the respective CEO compensation.

Answering these questions with respect to the analysed paper in addition to our collected data yield a perfect overview to which extent we can prove our hypothesis.

After analysing the articles, we found studies and statements that were connected to each other highlighting similar results which could be verified under the use of our collected data.

BODY

In the past evidence, has shown that there exists a correlation between firm performance and executive compensation. Nonetheless studies have shown that “[…] executive compensation was remarkably flat from the end of World War II to the mid- 1970s, even though firms grew considerably during that time […]” which contradicts the development of executive payments in the recent years where “[…] executive pay and firms expanded at almost the same rate […]” .

An often-heard argument when it comes to the discussions about the payments of executives is that larger companies can justify their payments along to their size compared to smaller market participants but more on that later into our paper. “Hastings” recognises the link between company size and executive payments in his paper „Executive Compensation and Firm Performance” published in 2010. He highlights that larger firms can often afford to pay more to their top employees and executives and it is more social and ethically acceptable. Although it is important to keep Frydman and Sakes in mind as they stated that they found evidence that the correlation between firm size and CEO compensation increased from the mid-1980s and is still clearly visible nowadays.

In addition to that, stock-options as a payment method are still controversial as stock options often lead “[…] to an inability of boards to evaluate the true costs of this form of compensation […]” and often lead to criticism as data clearly shows that stock option payments in USA are clearly higher.

Other studies also point out that in addition to the inability to evaluate the true costs of stock-options they furthermore increase the probability to misrepresent the financial situation of a company much more than other bonuses .

Risks, managerial risks as well as social risks in terms of employees and responsibility are much higher in big international companies than small companies as you are able to get a better overview about individual employees where as in larger companies you easily lose track of your employees as an executive. This leads us to the conclusion that higher basic salaries and bonuses are also a compensation for the executives as they have to bear more risk and have to accept responsibility when it comes to internal errors of any kind as they have to carry responsibility.

Since we discovered a relation between CEO and top executive compensation, another question pops up: In case of crisis situations, why are management payments still very high when firms do not perform well?

According to Hastings’ analysis of pay-performance link before and during the financial crisis showed mixed results [Hastings, Troy K. (2010): “Executive Compensation and Firm Performance”]. It is pointed out that payments were strongly monitored after the crisis in the annual reports of the companies and new regulations were implemented. […] ”In the UK, the Remuneration Code came into effect in 2010 as a response to the allegation that