An empirical investigation of relative performance evaluation in UK chief executive compensation

Farmer, Mark A. (2011) An empirical investigation of relative performance evaluation in UK chief executive compensation. (PhD thesis), Kingston University, .


The purpose of this study is to examine how corporate performance influences Chief Executive Officer (CEO) pay in UK public listed companies. Specifically it is to identify evidence of relative performance evaluation in CEO pay, following the recommendation in the Combined Code (2003) to link long-term incentive compensation to relative firm performance. The major and a novel contribution of this study is the focus on the payments received by CEOs from performance-based long-term incentive schemes. The pay-for-performance relationship is investigated in a longitudinal setting using random and fixed-effect panel data estimation methods. An unbalanced panel of CEOs is drawn from 204 of the largest, nonfinancial UK companies, between 2003 and 2007. From a principal-agent theory perspective it is hypothesised that firm performance is positively associated with chief executive pay and from a relative performance evaluation theory perspective it is hypothesised that, whilst controlling for actual firm performance, peer group performance is negatively associated with chief executive pay. The CEO compensation data are hand collected exclusively for this study and provides a level of detail not previously found in the literature. The findings demonstrate that it is crucial to distinguish between the different elements of pay and the different performance conditions that attach to those elements in order to establish a comprehensive understanding of the pay-for-performance relationship. New and convincing evidence shows that actual bonus pay is determined relative to annual FTSE-350 market performance and actual long-term pay is determined relative to three-year FTSE-350 sector performance. These findings provide robust evidence that is consistent with the principal-agent framework of executive pay and corporate performance. This study may alleviate the concerns held by some stakeholder groups that pay is not clearly linked to corporate performance. These findings will be of particula r practical importance to investors who expect the interests of executives to be aligned with those of the company shareholders, via an incentive contract that rewards executives for enhanced corporate performance and consequently shareholder wealth maximisation. The findings also confirm that changes introduced to improve corporate governance practice in the field of executive pay are working to the benefit of shareholders.

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