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43 Indus. & Lab. Rel. Rev. 13-S (1989-1990)
Executive Pay and Firm Performance

handle is hein.journals/ialrr43 and id is 361 raw text is: EXECUTIVE PAY AND FIRM PERFORMANCE JONATHAN S. LEONARD* This study examines the effects of executive compensation policy and organizational structure on the performance of 439 large U.S. corporations between 1981 and 1985. Companies with long-term incentive plans enjoyed significandy greater increases in ROE (return on equity) than did companies without such plans, and by 1985 long-term incentive plans had been nearly universally adopted by large corpora- tions. Corporate success was not significantly related to the level of, or degree of equity in, executive pay, or to the steepness of pay differentials across executive ranks; it was, however, positively related to the extent of hierarchical structure, which appears to have been the primary mechanism for sorting individuals by human capital endow- ments and performance. A N executive who earns tens of millions of dollars in pay per year provokes a certain critical regard no matter how efficient his operations. Extremely high compensation tends to raise questions concerning the competitive nature of the labor market determining executive com- pensation, and the effective degree of shareholder oversight and control. It has been justified, however, as part of incen- tive systems designed to align executives' interests more closely with those of share- holders. This paper examines evidence on the * The author is Harold Furst Professor of Manage- ment Philosophy and Values at the Haas School of Business, University of California-Berkeley, and Research Associate at the National Bureau of Economic Research. For helpful comments, he thanks seminar participants at U.C.-Santa Barbara, U.C.-Berkeley, Stanford University, the National Bureau of Economic Research, and the Cornell Conference on Compensation and Firm Perfor- mance. He also thanks Edward Lazear, Graef Crystal, and Michael Guthman for their comments, Susan Sassalos for research assistance, and the Institute of Industrial Relations for its support. The proprietary data used in this analysis were provided on a confidential basis. competitive nature of executive and man- agerial labor markets. Most previous stud- ies of executive compensation have been limited to the CEO and a few other officers whose compensation must be divulged in accord with SEC regulations. This paper instead makes use of a large sample of executives without regard to whether their pay is in the public domain. Specifically, I examine executive pay pat- terns for more than 20,000 executives at 439 corporations between 1981 and 1985, with particular attention to the role of human capital, hierarchical structure, and employer in determining executive pay, and to evidence of persistent pay differen- tials across firms. I also present evidence on the extent of sorting across hierarchies, and on the responsiveness of executive base and bonus pay to unit and corporate performance. Evidence on those matters cannot, in its nature, conclusively establish whether the net effect of high executive salaries is to transfer wealth from shareholders or, through their incentive effects, to elicit effort from executives that results in improved firm performance and a gain Industrial and Labor Relations Review, Vol. 43, Special Issue (February 1990). © by Cornell University. 0019-7939/90/43SP $01.00 13-S

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