Executive Compensation

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EXECUTIVE COMPENSATION AND FIRM PERFORMANCE

DOES EXECUTIVE COMPENSATION INCREASE FIRM PERFORMANCE?
Sietse Compagner, Gibran Borst, Tom Bleijenberg

Introduction

The current state of the economy raises questions about executive compensation. Although the debate on whether or not bonuses are worth their while has been going on for a long time, a recent development made it even harder for firms to justify the salaries that are paid to executives. The development in question is the collapse of the real estate market in 2008. From that point on, the economic growth decreased and firms started to struggle for their survival. Probably the most well known example is the bailout of the ‘big three’, (GM, Ford and Chrysler) by the US government. Ever since the economy went into a recession, it is questioned more than ever whether the benefits of paying CEO’s excessive bonuses, outweighs the costs of such bonuses. The central goal of this paper is to examine whether such compensations have the desired effects, or are just simply necessary. Therefore, the research question will be: ‘Does executive compensation increase firm performance?’. Those who oppose to these compensations, often argue that when a company struggles to stay in business, a well paid executive can be the end of its very existence. Corporations have a different opinion, they often claim that they do not have a choice. ‘If we don’t pay up, our smartest minds will jump to our rivals’, is a common used argument among firms. Both sides have valid arguments, and that is the main source of the everlasting discussion.

We will try to give an answer to our research question, based on results of earlier studies. The base of our information will be a series of research papers. We will summarize these articles and compare the conclusions, in order to obtain a conclusion that answers our research question. We will start our research with an article about the effect of executive compensation on short term performance, by Patrick Bolton, José Scheinkman and Wei Xiong. The other articles we will examine are: ‘CEO superstars’ by U. Malmendier and G. Tate and ‘CEO Compensation’ by C. Frydman and D. Jenter.

Literature review

‘Pay for short-term performance: executive compensation in speculative markets.’ By Patrick Bolton, José Scheinkman and Wei Xiong

This paper was written after a wave of corporate scandals, that started in late 2001. Most of these scandals concerned executives, selling large parts of their company stock, only weeks before the stock price dropped massively. Events like these raised numerous questions, concerning the flaws in the executive compensation system. After the series of incidents, it was recognized that several boards employed compensation arrangements that were not in the shareholders’ interest. This article deals with the flaws in the executive compensation process. It will cover the question whether executives are overpaid, the role of managerial power and why executive compensation has increased so much over the past 15 years. In the introduction, the writers of this paper compare their work to a few other studies, and they conclude that other researchers have missed an important point: the rise of the internet and the technology bubble. According to the writers of this article, the root of the increase in executive compensation lies in the technology bubble. Earnings manipulation is the term that is used for executives artificially increasing earnings in order to increase their performance (on paper) and therefore their compensation. The manipulation ranges from a fairly innocent bonus to outright accounting fraud. The article tries to explain how speculative markets create incentives for this so-called earnings manipulation. The article emphasizes that not the conflict between the CEO and the shareholders is the problem, but the conflict between the current and future shareholders. To support this point, the researchers will start...
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