Managerial compensation and a firm's performance: Is there any relation?

The aim of the paper is to examine the effectiveness of tools used to eliminate or ameliorate the costs of the agency problem. We test the relationship between a company’s performance as measured by return on equity (ROE) and the size of the CEO compensation package. The agency theory was defined by Jensen and Meckling in their pioneering paper “Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure“, published in 1976. However, the corporate governance environment has changed since the seventies. It is quite common that the ownership and management of a firm are separated nowadays. The research focuses on the verification of the relationship between the performance of the firm and managerial compensation. The significant body of the existing research concludes that such a relationship does not exist, or it is very weak. It points to the ineffectiveness of the board of directors and incentive plans as tools to minimize the agency costs. Our data set consists of 74 companies traded in the US stock market. In our sample, 23 companies operate in the sector of basic materials and 51 in the consumer goods sector. Each company is represented by a multidimensional matrix of financial ratios and certain information regarding executive compensation and the composition of the board of directors. Information was obtained from definitive proxy statement (DEF14) forms. Both, financial ratios and corporate governance variables, cover a 10-year period from 2004 to 2013. Results of the model indicate a fuzzy relationship between the value of the compensation and both the performance of the company and the relative ineffectiveness of the board of directors in dealing with the agency problem.