Download This PaperEstimating the sensitivity of CEO compensation to gross versus net accounting performance
55 Pages Posted: 17 Aug 2011 Last revised: 4 Nov 2023
Date Written: October 9, 2023
Abstract
In an empirical estimation of the relation between CEO compensation and accounting-based firm and peer performance, researchers often define the performance variables net of CEO compensation expense. We analytically show that a researcher’s use of CEO compensation both as a regression’s dependent variable and as an expense in defining accounting-based independent variables introduces a covariance that biases the researcher’s estimated regression coefficients on focal-firm and peer performance either upwards or downwards. In a panel estimation of CEO compensation, we document empirical evidence of a downward absolute coefficient bias on net focal-firm performance and net peer performance. This evidence may help explain prior inferences of weak CEO incentives and limited usage of relative performance evaluation (RPE). Our results imply that in CEO compensation regressions, a researcher can remove estimation bias in inferring CEO incentives and RPE usage by using gross rather than net accounting performance variables, i.e., by adding back CEO compensation expense to net accounting measures.
Keywords: Compensation studies, Estimation bias, Managerial incentives, Measurement error, Pay-for-performance sensitivity, Relative performance evaluation
JEL Classification: J33, M40, M41, M46
Suggested Citation: Suggested Citation
Shane Dikolli (Contact Author)
University of Virginia - Darden School of Business ( email )
P.O. Box 6550
Charlottesville, VA 22906-6550
United States
4342431018 (Phone)