Comparative sectoral analysis of managerial compensation and firm performance

The problem of managerial compensation is still of great interest for many involved groups, including investors, financial analysts, and researchers. Incentive packages for chief executive officers (CEOs) are just a part of the “agency problem” that was defined by Jensen and Meckling (1976). The theoretical approach to dealing with the agency problem can be divided into two broad groups. In the first group, there are authors who assume that a CEO has a certain degree of managerial power that results in his or her ability to affect the board of directors in its decisions regarding the amount of CEO pay. Therefore, managerial compensations are considered excessive. Such authors are focused on searching for evidence of that managerial power. The second group of authors, on the other hand, believe that high CEO pay can be simply explained by natural market forces – a more intense competition in the market for talents (Frydman, 2007), or a rapid development in technology and growth in the size of companies as proposed by Kaplan (2010). It does not seem to us that one or the other approach throws more light upon the agency problem.

Nevertheless, such theoretical debates do not answer the fundamental question – Are CEOs overpaid? To be able to answer this question, a comparative base is needed and a measure of firm performance must be chosen. The Securities and Exchange Act of 1934, section 14 requires the disclosure of pay in relation to a firm’s performance. How such a relationship should be expressed is not clarified. Thus, the goal of our paper is a comparative sectoral analysis using information regarding managerial compensation obtained from firm proxy statements (form DEF14A) and evaluation of the relationship between CEO pay and a variety of performance measures, such as the most widely used common stock price, return on capital, and earnings per share. Our data set will consist of more than 100 of the largest companies from the following sectors: consumer goods, basic materials, industrial goods, services, and utilities. The observational period covers the ten years from 2004 to 2013. In our opinion, this data set provides a solid ground for both intra- and extra-sectoral comparisons based predominantly on the probability distribution and a firm’s relative position within the framework of a relevant peer group.