Strategic choice of chief executive officers\u27 compensation: An empirical analysis

This paper considers an agency model where the principals of the competing firms choose the compensation contracts of their agents strategically. It attempts to give new interpretations (i.e. strategic considerations) for the use of sales revenue and the industry performance measures in the compensation contracts of the Chief Executives. Empirical predictions are drawn from the basic agency model with competing firms and are tested using the cash compensation data of CEOs of 345 firms drawn from a wide variety of industries. The analysis demonstrates that the standard (single agency) result of selling the firm to a risk neutral agent does not hold good in a setting with competing agencies. It further finds that, in addition to the informational reasons (Holmstrom 1979, 1982), principals may wish to use the performance measures of the competing firms (or the industry) in the compensation contracts of their agents in order to gain a strategic advantage over their rivals. The analysis finds strong empirical evidence for some of the time series hypotheses examined and somewhat weak empirical evidence for the cross-sectional hypotheses. This work also tries to distinguish the hypotheses that are based on strategic interaction between competing firms from the hypotheses that are based on the informativeness criterion