Business Strategy and Performance Measures in CEO Compensation Contracts

Abstract

In this study, we examine how business strategies affect compensation contracting and performance evaluation. Using textual measures of business strategies derived from corporate 10-K filings, we find that firms adopting the operational excellence strategy place a higher compensation weight on accounting-based performance, while firms adopting the customer intimacy strategy tend to weigh market-based performance more than other firms. The results also show that firms focusing on the product leadership strategy grant more equity-based compensation to CEOs. Focusing on the explicit performance measures disclosed in firms’ proxy statements, we document that companies pursuing the product leadership strategy are more likely to employ learnings and growth performance measures to promote innovation activities, while companies adopting the customer intimacy strategy tend to use customer-based measures to enhance customer relationships. Finally, firms leaning towards the operational excellence strategy are more likely to adopt internal process measures to reduce costs and improve production efficiencies. Our study provides evidence that firms rely on business strategies when designing compensation contracts and selecting performance measures.

Keywords: Business strategy, performance evaluation, product leadership, customer intimacy, operational excellence

JEL Classification: M41, M48