The Relation between CEO Compensation and Past Performance

The Accounting Review, Forthcoming

47 Pages Posted: 19 Jul 2012

See all articles by Rajiv D. Banker

Rajiv D. Banker

Temple University - Department of Accounting

Masako N. Darrough

City University of New York - Baruch College - Stan Ross Department of Accountancy

Rong Huang

City University of New York (CUNY) - Stan Ross Department of Accountancy

Jose M. Plehn-Dujowich

Powerlytics. Inc.

Date Written: July 18, 2012

Abstract

This study focuses on the relation between current compensation and past performance measures as signals of a CEO’s ability. We develop a simple two-period principal-agent model with moral hazard and adverse selection and test theoretical predictions using CEO compensation data from 1993-2006. Consistent with the predictions, we find that salary (bonus) is positively (negatively) associated with past performance for both continuing and newly-hired CEOs. We also find that while current salary is positively associated with future performance, current bonus is not. As the model suggests, salary is adjusted to meet the reservation utility and information rent, and is positively correlated over time to reflect ability. Bonus serves to address moral hazard and adverse selection by separating high-ability agents into riskier contracts. Our results indicate that it is important to disaggregate cash compensation into salary and bonus components to understand the dynamic interaction between incentives and performance.

Keywords: executive compensation, past performance, salary, bonus, adverse selection, moral hazard

JEL Classification: J33, M41

Suggested Citation

Banker, Rajiv D. and Darrough, Masako N. and Huang, Rong and Plehn-Dujowich, Jose M., The Relation between CEO Compensation and Past Performance (July 18, 2012). The Accounting Review, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2111847

Rajiv D. Banker

Temple University - Department of Accounting ( email )

Philadelphia, PA 19122
United States

Masako N. Darrough

City University of New York - Baruch College - Stan Ross Department of Accountancy ( email )

One Bernard Baruch Way
New York, NY 10010
United States
646 312 3183 (Phone)
646 312 3161 (Fax)

Rong Huang (Contact Author)

City University of New York (CUNY) - Stan Ross Department of Accountancy ( email )

One Bernard Baruch Way, Box B12-225
New York, NY 10010
United States
(646)312-3204 (Phone)

Jose M. Plehn-Dujowich

Powerlytics. Inc. ( email )

P.O. Box 164
Mechanicsville, PA 18934
United States

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