Firm Performance and Compensation Structure: Performance Elasticities of Average Employee Compensation

Abstract:     
Agency costs are a cost of production, and firms that do a better job of minimizing these costs should exhibit better performance. This paper tests this hypothesis by calculating the performance elasticity of average employee hourly compensation for U.S. manufacturing firms. This elasticity indicates the degree of alignment between employee and shareholder objectives. The estimated elasticity is indistinguishable from zero in low performance firms, and it equals 0.193 in high performance firms. In these regressions, firm quality is measured by the propensity to outperform the industry average of returns to common stock. Separation by an alternate definition of firm quality, the S&P bond rating, generates similar results. While it is difficult to know whether an elevated performance sensitivity causes better firm performance, clearly the best performers in manufacturing industries link average employee pay to performance.

Number of Pages in PDF File: 33

JEL Classification: G3, J3, L1

working papers series