The effect of CEO compensation structure on firm performance : based on US financial firms 2010-2016

University*of*Amsterdam* ! ! ! ! *

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The!effect!of!CEO!compensation!structure!on!firm!

performance!

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Based*on*US*financial*firms*201082016*

Abstract* * This*paper*examines*the*effect*of*CEO*compensation*on*firm*performance.*US*financial*firms*between* 201082016*are*used.*The*relation*between*executive*pay*and*ROA*is*tested.*Moreover,*the*structure*of* the*compensation*package*is*measured.*No*significant*relation*between*the*total*compensation*and*firm* performance*was*found.*Cash*bonus*nor*base*salary*has*a*significant*effect*on*firm*performance.*Stock* and*options*awards*however*have*a*negative*effect,*based*on*the*results.*The*findings*are*determined*by* US*financial*firms.*Effects*of*the*compensation*structure*from*other*industries*or*countries*can*therefore* differ.* ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! Statement!of!originality! ! This*document*is*written*by*Student*Sebastiaan*Molenaars*who*declares*to*take*full*responsibility*for* the*contents*of*this*document.* I*declare*that*the*text*and*the*work*presented*in*this*document*are*original*and*that*no*sources*other* than*those*mentioned*in*the*text*and*its*references*have*been*used*in*creating*it.* The*Faculty*of*Economics*and*Business*is*responsible*solely*for*the*supervision*of*completion*of*the* work,*not*for*the*contents.*

Table!of!contents!

1.#Introduction# ! Berk*and*DeMarzo*(2007)*state*that*the*board*of*directors*makes*rules*on*how*the*firm* should*be*run*and*the*chief*executive*officer*institutes*these*rules.*The*executives*get*paid* through*a*compensation*package.*Bebchuk*and*Grinstein*(2005)*show*that*executive* compensation*has*increased*considerably*in*the*period*199382003.*They*also*state*that* executive*pay*rise*has*gone*far*beyond*the*growth*of*market*capitalization.*According*to* Bloomberg*(2017)*Intel*boosted*the*executive*compensation*package*with*the*30*percent* from*2015*to*2017.*The*ongoing*growth*of*the*executive*pay*leads*researchers*to*discuss* and*focus*on*this*specific*subject.** An*ongoing*growth*of*executive*pay*can*lead*to*problems.*Harris*(2009)*mentions* that*executive*pay*should*focus*more*on*efficacy*and*fairness.*He*explains*the*negative* relation*between*executive*pay*and*firm*performance,*leading*to*financial* misrepresentation.*CEO*compensation*improves*firm*performance*less*than*expected.** Banks*are*ranked*in*the*middle,*among*industries,*when*providing*CEO*incentives* trough*stock*compensation*(Yermack,*1995).*CEO*compensation*can*also*consist*of*stock* options.*Brian*et*al.*(1996)*find*that*the*introduction*of*stock*options*in*the*compensation* package*leads*to*a*empirically*significant*connection*between*executive*compensation*and* firm*performance.**However,*Dittman*and*Maug*(2007)*state*that*the*CEO*compensation* should*not*consist*of*options,*only*shares.*And*mention*that*the*base*salary*of*the* compensation*package*should*be*low.*They*find*that*stock*should*substitute*options*in*the* compensation*package.*To*keep*the*utility*constant,*base*salary*should*be*low.*The*articles* mentioned*above*show*that*there*are*different*findings*in*research*concerning* compensation*and*performance.* This*paper*examines*the*effect*of*the*compensation*structure*on*firm*performance.* Stock,*options,*cash*bonus*and*base*salary*are*the*four*main*components*of*the* compensation*package.*The*research*question*is:*What*is*the*effect*of*CEO*compensation* structure*on*firm*performance*in*the*US*financial*sector?* # The*relation*between*CEO*compensation*structure*and*firm*performance*are* examined*in*this*paper.*Firm*performance*will*be*measured*by*the*return*on*assets*(ROA).* Most*of*the*articles*mentioned*in*section*2*use*ROA*as*a*feasible*performance*measure,* therefore*ROA*is*used.*Houston*and*James*(1995)*find*that*CEO*compensation*is*lower*for*

banks*than*other*industries.*Therefore*the*difference*between*the*CEO*compensation* structure*for*banks*and*other*subindustries*is*examined.*The*effect*of*the*four*independent* compensation*variables*and*other*control*variables*on*ROA*is*tested*by*a*regression.*The* OLS*and*random*effects*model,*based*on*the*outcome*of*the*Hausman*test,*are*used.* * A*negative*relation*between*equity*based*pay*(stock*and*option*awards)*and*firm* performance*is*found.*No*relation*is*found*between*cash*compensation*(cash*bonus*and* base*salary)*and*performance.*Based*on*the*regression*results,*the*control*variable*firm*size* has*a*positive*effect*on*performance.*However,*total*assets*have*a*negative*effect.*** * Following*the*introduction,*the*theoretical*background*regarding*this*topic*is* discussed.*The*methodology*will*be*presented*in*section*3,*including*the*research*method* and*data*selection.*Thereafter*the*descriptive*statistics*and*regression*results*are*examined* in*section*4.*Finally*the*conclusion*and*limitations*are*discussed.*

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2.#Literature#Review# * 2.1!Theoretical!Background! * Bebchuk*and*Grinstein*(2005)*show*that*executive*compensation*has*increased*considerably* in*the*period*199382003.*They*also*state*that*the*executive*pay*rise*has*gone*beyond*the* growth*of*market*capitalization.*The*growth*of*the*executive*compensation*has*not*been* consistent*with*the*growth*of*firm*size,*performance*and*industry*classification.*The*growth* of*compensation*between*200182003*doubled*relative*to*years*199381995,*10%*and*5%* respectively.*Equity*based*compensation*has*grown*the*most,*this*is*not*due*to*a*decrease*in* cash*compensation.*Guthrie,*Sokolowsky*and*Wan*(2012)*find*evidence*that*board*members* that*are*less*affiliated*with*the*company’s*performance,*also*known*as*board*independence,* does*not*affect*CEO*pay.*Board*independence*Compensation*committee*independence* however*does*affect*the*level*of*CEO*pay.** Moreover,*Dah*and*Frye*(2017)*show*that*more*compensation*of*executives*are* rather*over8*than*undervalued.*Overcompensated*executives*reduces*the*CEO*turnover*to* performance*and*leads*to*less*pay8for8performance*sensitivity.*Therefore*overcompensation* does*not*lead*to*focus*on*the*protection*of*shareholders’*interests.* Dodonova*and*Khoroshilov*(2014)*examine*the*effects*of*linear*(stock*based)*and* convex*pay*(option*based)*on*performance.*Per8unit*pay*has*a*positive*non8linear*effect*on* performance,*however*increasing*the*pay*doesn’t.*Option*based*pay*(convex)*leads*to*a* higher*pay8to8performance.* In*addition,*Fahlenbrach*and*Stulz*(2010)*investigate*the*causality*between*firm* performance*and*chief*executive*officer*incentives*and*compensation*in*the*banking*sector,* before*the*crisis.*The*performance*is*firstly*measured*by*stock*returns.*Return*on*assets* (ROA)*and*return*on*equity*(ROE)*are*also*used*to*measure*the*performance*of*a*bank.*They* conclude*that*stock*options*nor*cash*bonus*has*negative*on*the*performance*of*a*bank* during*the*crisis.*However*chief*executive*officers*with*less*shareholder*incentives,*don’t* have*worse*banking*performance*during*this*period.*They*found*evidence*that*higher*valued* chief*executive*officer*incentives*of*banks*performed*significantly*worse*(Fahlenbrach*&* Stulz,*2010).* On*the*contrary,*Dittman*and*Maug*(2007)*state*that*the*CEO*compensation*should* only*consist*of*stock*regarding*equity*compensation.*And*state*that*next*to*stock*awards,*

the*base*salary*of*the*compensation*package*should*be*low.*They*find*that*stock*should* substitute*options*in*the*compensation*package.*To*keep*the*ultility*constant,*base*salary* should*be*low.*This*structure*will*lead*to*20%*less*costs*and*the*same*incentives.*Due*to*the* cost*reduction*and*constant*utility*and*incentives,*the*compensation*package*should*consist* of*only*stock*and*low*base*salary.** DeYoung*et*al.*(2010)*investigate*the*relation*between*risk*taking*due*to*risk*based* incentives*compensation*of*bank*CEOs.*Strong*evidence*was*found*that*this*type*of* compensation*package*leads*to*growth*opportunities*for*banks.*This*relation*was*strongest* after*technological*enhancement*and*deregulation,*which*leads*to*more*capacity*for*risk* taking.*Bank*board’s*alternatively*adjusted*the*CEO*compensation*package*to*seek*growth* opportunities.* Furthermore,*a*positive*relation*between*executive*compensation*and*US*firm*size* and*performance,*is*found*by*Conyon*(2014).*Firm*performance*is*measured*by*ROA*and* shareholders*returns.*ROA*is*often*used*as*a*performance*measure.*Antle*and*Smith*(1985)* state*that,*ROA*is*a*traditional*financial*accounting*measure*of*performance.*They*mention* that*incentive*plans*are*tied*to*ROA.*A*relation*between*ROA*and*incentive*plans,*formed*by* compensation,*is*therefore*expected.**Stock*options*as*a*part*of*the*compensation*package,* has*become*more*important*over*time*(Conyon,*2014).*Due*to*self8regulation*compensation* committees*have*become*more*independent*over*time.*The*independence*leads*to*more* power*for*the*compensation*committee*to*determine*the*structure.*Mehran*(1995)*also* finds*a*positive*relation*between*the*percentage*CEO*equity*based*compensation*and*firm* performance,*measured*by*ROA.* Core*et*al.*(1999)*suggest*that*firms*with*agency*problems*are*aligned*with*large* executive*compensation.*Firms*with*greater*information*asymmetry*between*owner*and* CEO*perform*worse.*Compensation*variables*show*a*negative*relation*with*firm*operating* and*stock*return*performance.*A*positive*relation*between*executive*compensation*and*risk* taking*in*the*banking*sector*is*examined*(Houston*&*James,*1995).*Bank*CEOs*receive*less* cash*compensation*and*hold*fewer*stock*options*relative*to*other*US*firms,*due*to*the* nature*of*a*bank’s*assets.*They*find*a*significant*positive*correlation*between*equity* incentives*and*the*value*of*a*bank’s*charter.*Little*evidence*of*a*relation*between* compensation*and*promotional*risk*taking*is*found.*As*a*result,*the*compensation*package*is* not*designed*to*take*risk*in*the*banking*sector.**

Gopalan,*Milbourn,*Song*and*Thakor*(2014)*examine*the*effect*of*duration*of* executive*compensation.*Executive*compensation*can*be*based*on*short8*or*long*term.* Shorter8term*executive*compensation,*based*on*cash*and*salary,*has*an*incentive*to* manipulate*short8term*performance*as*effect.*Long*term*incentive*compensation*consists*of* equity.*They*find*that*long*term*compensation*contracts*have*a*higher*compensation,*on* average.*Executive*pay*can*manipulate*earnings,*and*therefore*the*performance*(measured* as*ROA).*When*executive*compensation*is*equity*based,*due*to*stock*and*option*awards,* manipulation*of*recorded*earnings*occurs*more*(Bergstresser*&*Philippon,*2006).*Equity* based*incentives*can*therefore*have*a*negative*effect*on*ROA.*Dittmann*et*al.*(2011)* mention*that*larger*fixed*compensation*makes*the*contract*more*valuable,*but*does*not* improve*the*performance*incentives.*In*addition,*Ozkan*(2007)*finds*a*positive*relation* between*CEO*cash*compensation*and*firm*performance.** Finally,*the*characteristics*of*an*executive*effects*the*compensation*structure.* According*to*Humphrey8Jenner*et*al.*(2015)*overconfidence*of*an*executive*leads*to*a*higher* compensation.*Executives*with*biased*positive*views*of*the*firm’s*prospects,*and*therefore* performance,*receive*more*equity*based*incentives.*Riskier*firms*offer*higher*incentives* compensation*to*overconfident*executives.*Behavioral*characteristics*of*an*executive*can* therefore*influence*the*compensation*structure.** * Otto*(2014)*also*studies*the*effect*of*executive*characteristics*on*compensation.* CEOs*with*optimistic*indicative*behavior*regarding*option*exercising,*receive*lower*total* compensation*than*their*peers*(Otto,*2014).*This*shows*that*firms*take*executive* characteristics*into*account*when*structuring*the*compensation*package.** * * 2.2!Hypotheses! * Dittman*and*Maug*(2007)*conclude*that*the*compensation*package*should*consist*of*stock* and*no*options*partly*based*on*firm*performance.*This*is*however*based*on*the*costs*of*the* compensation*package*as*well,*and*not*solely*on*firm*performance.*Hamid*(1995)*finds*a* positive*effect*of*percentage*equity*based*compensation,*which*includes*stock*and*options,* on*ROA.*In*addition,*Dodonova*and*Khoroshilov*(2014)*find*a*positive*relation*between* option*based*pay*and*firm*performance.*The*findings*of*Hamid*(1995),*Dodonova*and*

Khoroshilov*(2014)*lead*to*an*expected*positive*of*stock*and*options*awards*on*firm* performance.*Fixed*compensation*will*not*induce*performance*incentives*(Dittmann*et*al.* 2011).*Therefore,*no*relation*between*base*salary*(fixed*compensation)*and*performance*is* expected.*Cash*compensation,*including*cash*bonus,*has*a*positive*effect*on*performance* (Ozkan,*2007).*A*positive*relation*between*cash*bonus*and*firm*performance*is*therefore* expected.**Conyon*(2014)*finds*a*positive*relation*between*executive*compensation*and*firm* performance.*On*the*contrary,*Core*et*al.*(1999)*find*a*negative*relation.*Based*on*the* findings*of*the*majority*of*articles,*a*positive*effect*of*total*executive*compensation*on*firm* performance*is*expected.*All*of*the*above*leads*to*the*following*hypotheses:* * Hypothesis!1:!Executive!compensation!has!a!positive!effect!on!firm!performance! Hypothesis!2:!Stock!awards!have!a!positive!effect!on!firm!performance.! Hypothesis!3:!Option!awards!have!a!positive!effect!on!firm!performance.! Hypothesis!4:!Cash!bonuses!have!a!positive!effect!on!firm!performance.! Hypothesis!5:!Base!salary!has!no!effect!on!firm!performance.! * *

3.#Methodology# * This*section*will*first*describe*the*applied*research*method.*The*different*variables*and* regression*model*will*be*explained.*Finally,*the*data*selection*will*be*described.* * 3.1!Research!Method! * The*main*objective*of*this*study*is*to*examine*the*effects*of*executive*compensation*on*firm* performance*in*the*US*financial*sector.*This*study*will*determine*if*executive*compensation* and*firm*performance*have*a*relation.*Not*only*executive*compensation*as*a*whole*will*be* examined,*but*also*the*structure*of*the*compensation*package.*The*effect*of*stock*awards* on*firm*performance*will*also*be*examined*relative*to*option*and*cash*compensation.*The* relative*relation*will*also*be*examined*vice*versa.*Coughlan*and*Smith*(1985)*find*a*positive* relation*between*compensation*change*and*firm*performance,*measured*by*stock*prices.* This*paper*will*examine*firm*performance*by*ROA.*ROA*is*a*traditional*financial*accounting* measure*of*performance,*due*to*the*link*between*performance*incentives*and*ROA*(Antle*&* Smith,*1985).*Multiple*other*mentioned*studies*use*ROA*as*firm*performance*measure* (Mehran*1995,*Conyon*2014,*Fahlenbrach*and*Stulz*2010).*The*structure*of*the*CEO* compensation*of*the*financial*firms*will*be*examined*by*the*descriptive*statistic*results.* Houston*and*James*(1995)*find*that*banks*have*lower*cash*compensation*and*stock* holdings.*Therefore*the*means*of*the*compensation*variables*will*be*compared*between* banks*and*other*subindustries*in*the*financial*sector.*OLS*regression*will*be*applied*to*find* the*effects*between*firm*performance*and*the*independent*variables.*Moreover,*the*model* determined*by*the*Hausman*test*(fixed8*or*random*effects*model)*will*be*applied*to*certify* the*OLS*regression*results.* * 3.2!Regression!model! ! ! ! The*regression*model*is*based*on*the*introduced*variables*below:! !

!!"#$ = &'()*+,#-./01$+ &3"4)5*6#-./01$ + &78.1ℎ:*6;1$ +

! ROA*(ROA)*will*be*used*as*the*dependent*variable*in*the*regression*model.*According*to* multiple*studies*ROA*is*used*as*feasible*firm*performance*measure*(Mehran*1995,Conyon* 2014,*Fahlenbrach*&*Stulz*2010*and*Antle*&*Smith*(1985)).*ROA*is*measured*by*dividing*the* net*income*by*the*total*assets,*for*the*respective*years.*! * Stock*awards*(StockAwards)*consist*of*the*value*of*the*stocks*received*by*the* executive,*through*their*compensation*structure.*The*value*is*based*on*the*stock*based* awards*in*the*fiscal*year,*provided*by*Compustat.*Stock*awards*consist*of*restricted*stock,* which*consists*of*shares*blocked*for*multiple*years.*Stock*based*compensation*increased*in* the*90s*(Bryan*et*al.,*2000).*The*percentage*of*firms*granting*stock*based*awards*increased* from*54%*to*72%*in*that*period.*Gaver*and*Gaver*(1993)*show*that*larger*firms*rely*more*on* stock*based*awards.** * Option*awards*(OptionAwards)*contain*the*awarded*option*to*the*executives* presented*by*Compustat.*The*value*is*based*on*the*option*related*awards*of*an*executive*of* a*financial*firm,*in*the*fiscal*year*detailed*in*the*accounting*standards*of*the*firm.*Executives* may*strategize*to*hedge*risk*related*to*the*awarded*options*(Ofek*&*Yermack,*2000).*Bryan* et.*al*(2000)*shows*that*stock*options*have*a*higher*incentive*intensity*than*restricted*stock.* * The*cash*compensation*is*based*on*the*cash*bonus*(CashBonus)*and*base*salary* (BaseSalary)*retrieved*in*the*fiscal*year*by*a*financial*firm.*According*to*Bryan*et*al.*(2000)* cash*compensation*is*unlikely*to*provide*incentives*for*the*executive,*due*to*the*exhibition* of*volatility*by*the*firm.*Large*firms*rely*less*on*cash*compensation*than*stock*option*awards* (Gaver*&*Gaver*1993).** * Total*compensation*(lnTotal)*is*the*natural*logarithm*of*the*amount*presented*by* Compustat*for*the*respective*firms.*The*percentages*of*the*CEO*compensation*components* mentioned*above*will*be*measured*by*dividing*the*relevant*component*by*the*total* compensation.* * Firm*size*(FSize)*measures*the*size*of*the*relevant*financial*firm.*This*is*a*control* variable*for*the*firm*performance.*The*size*is*determined*by*the*natural*logarithm*of*the* amount*of*employees.* * Total*assets*(lnAssets).*The*natural*logarithm*of*the*total*assets*of*the*respective*firm* for*the*fiscal*year*will*be*used*as*a*control*variable.*

Industry*dummy*(Bank)*determines*the*industry*of*the*respective*financial*firm.* When*the*firm*represents*the*baking*industy,*the*value*will*be*1.*All*other*subindustries*in* the*financial*sector*will*be*given*the*value*0.*The*industry*will*also*contribute*as*a*control* variable,*to*examine*any*differences*in*effects*between*subindustries.* * * * * 3.3!Data!selection! * The*selection*of*data*will*be*the*sample*of*the*S&P*500*firms*in*the*financial*sector.*51*firms* from*the*database*are*subjected*to*the*financial*sector*in*the*S&P*500.*Wharton*Research* Data*Services*(WRDS)*is*the*selected*data*service*for*the*use*of*Compustat’s*Execucomp*to* retrieve*the*dataset*of*the*executive*compensation*and*respective*variables.*Compustat*is* also*used*to*retrieve*the*net*income*and*total*assets*of*the*respective*firm*in*the*five*fiscal* years*after*the*crisis*(January*2010*till*December*2016)*to*determine*the*ROA.*Multiple* studies*use*Compustat’s*Execucomp*to*retrieve*executive*compensation*values*(DeYoung*et* al.,*2010;*Fahlenbrach*&*Stulz,*2010;*Gopalan*et*al.,*2014*and*Bhagat*&*Bolton,*2014).* Fahlenbrach*and*Stulz*(2010)*examine*the*effect*of*executive*compensation*during*the* crisis.*This*paper*will*examine*the*years*after*the*crisis,*to*determine*effects*of*the* compensation*structure*on*firm*performance.*The*introduced*hypotheses*in*section*2*and* regression*model*above*lead*to*the*following*mathematical*hypotheses:* * * 1H0:*!5*=*0.*H1:*!5*

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4.#Empirical#test#and#results# The*descriptive*statistics*of*the*different*variables*are*discussed*in*this*section.*Significant* differences*between*the*means*for*banks*and*other*subindustries*are*examined.*Finally,*the* regression*results*will*be*determined*and*explained.*! ! 4.1!Descriptive!results! * The*summary*statistics*are*presented*in*table*1.*The*means*are*divided*into*the*subindustry* banks*and*other*subindustries,*representing*the*dummy*variable.*A*two8sample*t8test*is* used*to*determine*a*significant*difference*between*the*means*of*a*bank*or*other* subindustry*for*each*variable.*Banks*represent*26*of*the*51*financial*companies*researched.* * Banks*have*an*average*ROA*of*0.0237*between*201082016.*While*the*other* subindustry,*such*as*an*asset*management*and*insurance*company,*have*an*average*ROA*of* 0.0471.*Table*1*shows*that*the*ROA*of*banks*is*significantly*lower*than*the*ROA*of*other* subindustries.** * The*average*CEO*compensation*package*of*a*bank*consists*44.5%*stock*awards.* Other*subindustry*companies*award*CEO’s*35.2%*consisting*of*stock.*The*difference* between*these*means*is*significant,*according*to*table*1.*Bechuk*and*Grinstein*(2005)*find* an*increase*in*equity*based*compensation,*this*is*in*line*with*means*throughout*the*years*for* banks*and*other*subindustries*(Appendix*A).** * On*the*contrary*companies*with*a*subindustry,*other*than*banks,*have*significantly* higher*options*awards*than*banks*on*average.*Banks*have*an*option*award*package*of*7.7%* relative*to*11.7%.*** # Both*subindustries*have*a*cash*bonus*between*26.5%*and*25%,*and*base*salary* between*13%*and*15%*of*the*total*compensation*on*average.*The*average*cash*and*salary* compensation*between*banks*and*other*subindustry*companies*don’t*have*a*significant* difference.*This*is*not*in*line*with*the*findings*of*Houston*&*James*(1995),*however*this* could*be*based*on*the*difference*in*year*periods.* * Finally,*on*average*the*total*compensation*is*significantly*higher*for*banks*than*other* subindustries,*the*variable*is*based*on*the*natural*logarithm.*Both*the*size,*measured*by*the* number*of*employees,*and*the*total*assets*are*significantly*higher*for*banks.**

! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! Table!1!(!!Summary!statistics!with!dependent!variable!'ROA'!! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !!

!! Subindustry:!Bank! !! !! !! !! !! !! Subindustry:!Other! !! !! !! !! !! Bank!vs!Other!

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!! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !!

Variable! Mean! !! SD! !! Min! !! Max! !! !! !! Mean! !! SD! !! Min! !! Max! !! Mean! !!

!! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! ROA! 0.024! !! 0.045! !! (0.006! !! 0.0239! !! !! !! 0.047! !! 0.088! !! (0.011! !! 0.533! !! (0.023! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! (0.007)! ***! %!Stock!Awards! 0.445! !! 0.203! !! 0! !! 0.899! !! !! !! 0.352! !! 0.211! !! 0! !! 0.860! !! 0.092! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! (0.022)! ***! %!Options!Awards! 0.077! !! 0.106! !! 0! !! 0.462! !! !! !! 0.117! !! 0.118! !! 0! !! 0.545! !! (0.040! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! (0.012)! ***! %!Cash!Bonus! 0.251! !! 0.164! !! 0! !! 0.829! !! !! !! 0.263! !! 0.128! !! 0! !! 0.707! !! (0.012! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! (0.015)! !! %!Base!salary! 0.132! !! 0.143! !! 0.021! !! 0.963! !! !! !! 0.145! !! 0.111! !! 0.037! !! 1! !! (0.013! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! (0.014)! !! lnTotal! 16.14! !! 0.619! !! 14.23! !! 17.14! !! !! !! 15.81! !! 0.958! !! 11.35! !! 17.44! !! 0,332! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! (0.085)! ***! lnSize! 10.07! !! 1.15! !! 7.55! !! 12.57! !! !! !! 9.42! !! 1.46! !! 6.25! !! 12.81! !! 0.642! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! (0.139)! ***! lnAssets! 25.72! !! 1.56! !! 22.02! !! 28.58! !! !! !! 24.71! !! 1.63! !! 19.35! !! 27.53! !! 1.01! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! (0.169)! ***! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! N! 182! !! !! !! !! !! !! !! !! !! 175! !! !! !! !! !! !! !! 357! !! Note:&the&difference&in&means&is&tested&by&a&t3test,& !! !! !! !! !! !! !! !! _! !! !! !! !! !! !! !! using!subindustries.! && && !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !!

! ! ! 4.2!Regression!results! ! In!this!section!a!regression!is!constructed!to!measure!a!relationship!between!the!ROA! (dependent!variable)!and!the!compensation!methods!(independent!variables).!First!the! OLS!results!will!be!presented.!Thereafter,!the!random!effects!model!results!are! discussed.! ! Table!2!presents!the!outcome!of!the!OLS!results.!In!regression!1,!no!effect!is! found!between!percentage!stock!awards!and!firm!performance!(t=F0,96;!p=0,337).!This! is!not!in!line!with!the!findings!of!Dittmann!and!Maug!(2007),!concluding!the! compensation!package!should!consist!of!stock.!However!this!is!in!line!with!the!findings! of!Fahlenbrach!and!Stulz!(2001).!Therefore,!a!higher!or!lower!percentage!pay!out!in! stock!awards!for!a!CEO!will!not!affect!the!ROA!of!a!financial!firm.!! ! A!negative!relation!is!found!between!option!awards!and!ROA!(t=F3,4;!p=0,001).! This!contradicts!the!findings!of!Hamid!(1995),!Dodonova!and!Khoroshilov!(2014).!Raising! the!percentage!of!option!awards!for!a!CEO!with!1%!will!negatively!affect!the!ROA!with! 0,098%,!based!on!the!OLS!results!(table!1).! ! Cash!bonus!nor!base!salary!have!an!effect!on!firm!performance!(t=1,02;!p=0,308! and!t=F1,95;!p=0,052).!This!is!in!line!with!the!paper!of!Dittmann!et!al.!(2011).!But! contradicts!the!conclusions!of!Ozkan!(2007).!A!percentage!change!in!cash!bonus!or!base! salary!will!not!affect!the!firm!performance!for!financial!firms.!In!addition,!the!total! compensation!does!not!have!an!effect!on!the!ROA!(t=F0,08;!p=0,938).! Two!of!the!three!control!variables!on!the!ROA!have!an!effect.!Both!the!firm!size! and!total!assets!have!a!positive!and!negative!effect!respectively!(t=5,79;!p=0,00!and!t=F 16,07;!p=0,00).!Moreover,!the!dummy!variable!for!subindustry!(bank)&does!not!have!an! effect.! ! Second,!the!results!of!the!random!effects!model!are!discussed.!In!addition,!any! differences!with!the!OLS!results!will!be!determined.!The!Hausman!test!is!run!to! determine!which!model!is!appropriate.!Appendix!B!shows!the!random!effects!model!is! appropriate!(p=0,059).!Furthermore,!the!Breusch!and!Pagan!test!is!used,!to!conclude!

that!the!random!effects!model!is!the!appropriate!model.!Since!the!pFvalue!is!significant,!! the!random!effects!model!is!indeed!appropriate!(p=0,00;!Appendix!B).!! ! The!second!regression!of!table!2!presents!the!results!of!the!random!effects! model.!The!percentage!stock!awards!of!the!CEO!compensation!package!has!a!significant! relation!with!the!firm!performance!(ROA)!of!a!financial!firm.!Stock!awards!have!a! negative!effect!on!ROA!(t=F2,71;!p=0,007),!this!contradicts!the!findings!by!Fahlenbrach! and!Stulz!(2010),!where!they!find!a!positive!impact!on!firm!performance,!also!measured! by!ROA.!This!is!not!in!line!with!the!OLS!results.! ! Second,!a!significant!effect!of!the!option!award!percentage!on!firm!performance! is!found.!A!significant!negative!effect!is!determined!(t=F3,87;!p=0,00),!this!is!not!in!line! with!the!findings!by!Dodonova!and!Khoroshilov!(2014).!A!positive!relation!between! option!based!pay!and!performance!is!found!by!them.!However,!the!negative!effects!of! stock!and!option!based!pay!is!supported!by!the!findings!of!Core!et!al!(1999).!They! determine!a!negative!effect!of!compensation!variables!on!performance.!Furthermore,! no!significant!results!were!found!for!cash!bonus!and!base!salary.!! The!size,!measured!by!employees,!and!total!assets!of!the!firm!both!have!a! positive!and!negative!significant!effect!respectively!(t=2,05;!p=0,04!and!t=F5,64;!p=0,00).!! ! Finally,!no!significant!effect!is!found!between!the!dummy!subindustry!variable! and!ROA.!Therefore!a!difference!between!the!effect!of!the!CEO!compensation!structure! on!ROA!between!banks!and!other!subindustry!companies,!cannot!be!determined.! ! !The!same!significant!positive!and!negative!effects!were!found!for!OLS!and! random!effects!model.! ! ! ! ! ! ! ! ! ! ! ! ! ! !

! ! ! Table!2!F!OLS!and!Random!effects!model!regression!results!with!dependent!variable! 'ROA'!! !! !! !! !! !! !! !! !! !! !! !! !!

Independent!Variables! OLS! !! REM! !! !! !! !! !! !! !! !!

!! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! Stock!Awards! F0.019! !! F0.026! !! !! !! !! !! !! !! !! !! (0.019)! !! (0.010)! ***! !! !! !! !! !! !! !! Option!Awards! F0.097! !! F0.053! !! !! !! !! !! !! !! !! !! (0.027)! ***! (0.014)! ***! !! !! !! !! !! !! !! Cash!Bonus! F0.025! !! F0.004! !! !! !! !! !! !! !! !! !! (0.024)! !! (0.011)! !! !! !! !! !! !! !! !! Base!Salary! F0.060! !! F0.029! !! !! !! !! !! !! !! !! !! (0.031)! !! (0.015)! !! !! !! !! !! !! !! !! lnTotal! 0.000! !! 0.002! !! !! !! !! !! !! !! !! !! (0.005)! !! (0.003)! !! !! !! !! !! !! !! !! lnSize! 0.018! !! 0.010! !! !! !! !! !! !! !! !! !! (0.003)! ***! (0.005)! **! !! !! !! !! !! !! !! lnAssets! F0.041! !! F0.026! !! !! !! !! !! !! !! !! !! (0.003)! ***! (0.005)! ***! !! !! !! !! !! !! !! Bank! 0.003! !! 0.004! !! !! !! !! !! !! !! !! !! (0.005)! !! (0.015)! !! !! !! !! !! !! !! !! N! 357! !! 357! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !! !!

Note:&Regression&1&shows&the&OLS&regression&results& && && && && && && && && Note:&Random&effects&model,&based&on&the&Hausman&test.&Appendix&B&& !! !! !! !!

Note:&Dependent&and&independent&variables&are&discussed&in&section&3.& !! !! !! !!

Note:&***(**)&significant&at&1%&(5%)&according&to&twoKsided&test.& !! !! !! !! !!

5.!Conclusion!and!discussion! ! This!paper!researched!what!the!effect!of!CEO!compensation!structure!on!firm! performance!in!the!US!financial!sector!is!for!the!years!2010F2016.!! The!regression!results!show!that!the!total!compensation!does!not!affect!firm! performance!for!financial!firms,!which!is!not!in!line!with!the!first!hypothesis.!!Stock! awards!have!a!significant!negative!effect!on!ROA.!While!the!expectation!was!that!stock! awards!would!have!a!positive!relation!with!firm!performance.!The!findings!are!therefore! not!in!line!with!the!second!hypothesis.!According!to!Dittmann!and!Maug!(2007)!stock! awards!are!necessary!for!an!optimal!compensation!package.!Based!on!firm! performance,!the!findings!of!this!paper!contradicts!their!study.!Furthermore!a!significant! negative!effect!of!option!awards!on!firm!performance!was!found.!This!is!however!in!line! with!the!findings!of!Dittmann!and!Maug!(2007),!but!contradicts!the!study!by!Dodonova! and!Khoroshilov!(2014).!The!findings,!regarding!option!awards,!are!not!in!line!with!the! third!hypothesis.!No!relation!was!found!for!cash!bonus!nor!base!salary.!This!is!not!in!line! with!the!fourth!hypothesis.!On!the!contrary,!the!fifth!hypothesis!is!acknowledged.!! Based!on!the!findings!the!equity!based!compensation!has!a!negative!effect!on! firm!performance,!and!the!cash!compensation!variables!have!no!effect.!These!results! advise!compensation!committees!of!financial!firms!to!overview!the!equity!based! compensation!values.!Compensation!committees!should!lower!the!stock!and!option! awards!and!replace!with!cash!compensation,!based!on!the!results!of!this!paper.!This!is! advised!for!firms!structuring!the!CEO!compensation!package!to!create!incentives!for!a! higher!ROA.!Further!research!can!examine!the!incentives!of!the!CEO!compensation! structure!and!determine!how!the!equity!based!compensation!is!not!aligned!with!a!firm! performance!measure.! ! Firstly!the!results!are!based!on!the!years!2010F2016.!The!effect!of!compensation! structure!on!firm!performance!can!be!different!in!other!years.!Since!the!years!2010F 2016!are!after!the!financial!crisis,!a!rise!of!the!firm!performance!(ROA)!can!therefore! minimize!the!found!effects!of!CEO!executive!compensation.! ! Secondly,!the!findings!are!based!on!the!US!financial!sector.!Houston!and!James! (1995)!find!differences!in!compensation!between!banks!and!other!industries.!A!different! compensation!structure!of!other!industries!or!countries!can!have!a!different!relation!

with!firm!performance.!Therefore!assumptions!for!the!respective!period!in!other! countries!or!sectors!cannot!be!made.!! ! ! ! ! ! ! ! ! !

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Appendices!

Subindustry:!Bank

Stock Options Cash Base!Salary

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% 2010 2011 2012 2013 2014 2015 2016

Subindustry:!Other

!

Appendix!B.!Hausman!&!Breusch!and!Pagan!!

!

Appendix!B!F!!Hausman!&!Breusch!an!Pagan!test!

!! !! !! !!

Variable! Hausman! !! Breusch!and!Pagan!

!! !! !! !!

!! !! !! !!

pFvalue! 0.058! !! 0.000***!

!! !! !! !!

Note:&Hausman:!H0:!Random!effect!model!H1:!Fixed!effect!model.

Note:Breusch!and!Pagan:!H0:!Pooled!regression!H1:!Random!effect!model! & ! ! ! ! !