Faculty Scholarship 1994 - Present

A Truer Measure of Risk in Executive Cash Compensation

Two schools of thought have informed the debate over the rationality of executive compensation. The "agency theory" approach considers the problem of how shareholders can structure the contracts of executives so as to mutually align their interests. The "managerialism" approach assumes that shareholders are unable to control managers, and that executives enrich themselves at shareholders' expense. We study the effects of CEO cash bonuses on firm performance. Pay mix has traditionally been measured as bonus divided by salary. In this paper, we propose an alternative measure of pay mix: year-to-year change in bonus, divided by salary. Using a different and newer data set, we replicate two previous studies of the effect of pay mix on firm performance, comparing our measure to the traditional measure, and find that our measure is more strongly associated with firm performance. Thus, our results lend additional support to the agency theory view of executive compensation.