The Implications of Strategy in Executive Compensation Design

Sammanfattning: The aim of this study is to investigate the relationship between executive compensation design and firm performance. With respect to the design of compensation, we consider the percentage share of executives' total remuneration that is attributed to performance-linked compensation (PLC). Furthermore, we examine the impact that business strategy has on the relationship. This is tested by using business strategy as a moderating variable. The regression models employed are quadratic and the dependent variable, firm performance, is proxied by ROA and Tobin's Q. We find that the share of PLC in executive pay contracts is positively associated with ROA but not with Tobin's Q. Business strategy is found to moderate the relationship between PLC and ROA. This is not the case for Tobin's Q, however. Firms are classified, in line with Porter's definition, as either pursuing a differentiation or cost-leadership strategy. Differentiators are found to benefit from high levels of PLC, while cost-leaders benefit from employing pay policies that compensate their executives with a more balanced mix between performance-linked and fixed pay items. The study is conducted on publicly listed firms in the United States from the period 2006-2020. The results of the study contributes to the executive compensation literature with regard to how the appropriate level of PLC in executive pay contracts differs depending on the firm's pursued business strategy.