Estimating the sensitivity of CEO pay to accounting-based performance: gross versus net measures

58 Pages Posted: 17 Aug 2011 Last revised: 24 Jul 2021

See all articles by Dirk E. Black

Dirk E. Black

University of Nebraska at Lincoln - School of Accountancy

Shane S. Dikolli

University of Virginia - Darden School of Business

Christian Hofmann

Ludwig Maximilian University of Munich (LMU) - Faculty of Business Administration (Munich School of Management)

Thomas Pfeiffer

University of Vienna - Accounting and Control

Date Written: July 23, 2021

Abstract

In the empirical estimation of the relation between CEO pay and both firm and peer performance, researchers typically include conventional accounting-based measures that reflect firm performance net of executive pay expense. We analytically show that when firms evaluate CEO performance relative to peers, the coefficients on such net accounting measures are biased either upwards or downwards in the regression estimate of CEO incentives, relative to the Board of Directors’ choice of CEO incentives. Intuitively, net accounting measures include executive compensation, and the additional covariances bias the regression coefficients. In a cross-sectional estimation of CEO pay-for-performance sensitivity, we document evidence of, on average, an attenuation bias in the regression coefficients on focal-firm net performance and peer net performance. This evidence may help explain puzzling findings in prior work of both low CEO pay-for-performance sensitivity and a lack of widespread use of relative performance evaluation (RPE). Our results imply that in CEO pay regressions, a researcher can remove estimation bias in both CEO pay-for-performance sensitivity and RPE detection by using gross rather than net accounting measures, i.e., by adding back executive pay to net accounting measures for both the focal firm and peers in measuring performance.

Keywords: Executive Compensation, Relative Performance Evaluation, Performance Measurement

JEL Classification: J33, M40, M46

Suggested Citation

Black, Dirk E. and Dikolli, Shane and Hofmann, Christian and Pfeiffer, Thomas, Estimating the sensitivity of CEO pay to accounting-based performance: gross versus net measures (July 23, 2021). Available at SSRN: https://ssrn.com/abstract=1910819 or http://dx.doi.org/10.2139/ssrn.1910819

Dirk E. Black

University of Nebraska at Lincoln - School of Accountancy ( email )

307 College of Business Administration
Lincoln, NE 68588-0488
United States

Shane Dikolli (Contact Author)

University of Virginia - Darden School of Business ( email )

P.O. Box 6550
Charlottesville, VA 22906-6550
United States
4342431018 (Phone)

Christian Hofmann

Ludwig Maximilian University of Munich (LMU) - Faculty of Business Administration (Munich School of Management) ( email )

Kaulbachstr. 45
Munich, DE 80539
Germany

Thomas Pfeiffer

University of Vienna - Accounting and Control ( email )

Oskar-Morgenstern-Platz 1
Vienna 1090, Vienna
Austria
+43-1-4277-38002 (Phone)
+43-1-4277-38004 (Fax)

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