Is there a correlation between executive compensation and

firm performance?

By Rob Simmons

Over the last three decades, company executives, particularly CEOs, have enjoyed an im-

mense increase in their level of compensation, whether through salary, performance bonuses,

stock options, or all of the above. The magnitude of their compensation is even more staggering

when placed against the 99 percent of the American population who have seen their earnings

stagnate since the beginning of the last decade. Since the financial crisis of 2008, executives

have been under an increased level of scrutiny for collecting ever-higher levels of pay while their

employees are not collecting subsequent raises and many people remain out of work. Executives

like to justify their compensation as not just a reward for their company’s performance, but as a

form of motivation to further grow their company. CEOs have stated that high salaries and bonus

packages are needed for their companies to attract the best and brightest in their field. Has the

increased level of executive compensation over the last three decades led to stronger firm perfor-

mance? Is “pay for performance” a logical method of executive compensation, or have execu-

tives simply come up with an alluring rationale to justify their earnings? This research paper

seeks to establish if there is a correlation between executive compensation and firm performance.

Exactly how much has CEO pay increased over the years? According to the Economic

Policy Institute, CEO compensation increased 937 percent from 1978 to 2013, adjusted for infla-

tion. It is important to note that this increase is more than double the growth of the stock market

over the same time period.1 After-tax corporate profits have increased nearly as dramatically as

CEO pay, especially since 20002, yet workers as a whole have not been able to share in the spoils

of corporate victory. In the last 35 years, the annual compensation of private-sector production

and nonsupervisory workers has increased by 10 percent. Since 2009, compensation growth has

flatlined.3 Still, CEO pay continues to increase simply because corporate profits continue to in-

crease, which is followed by an increase in stock prices. Yet much of this increase in profits is

attributable to wage growth not keeping up with corporate growth. Furthermore, executive com-

pensation does not always correlate with the movement of stock prices, and stock prices, as well

as corporate profits, are not the be-all and end-all of measuring a firm’s true performance.

1 Lawrence Mishel and Alyssa Davis, “CEO Pay Continues to Rise as Typical Workers Are Paid Less”, Economic

Policy Institute, June 12, 2014. 2 Pat Garafolo, “Occupy Wall Street One Year Later: Ten Key Charts About Inequality”, Think Progress, September

17, 2012. 3 Mishel and Davis.

Previous academic research has shown the lack of correlation between the compensation

of highly-paid CEOs and their performance. An analysis of compensation data released by Equi-

lar compared the salaries of 200 highly paid CEOs to their respective companies’ stock returns.

Data was plotted on a graph according to CEO pay and stock return rankings instead of using

pure values. The stock return rank is on the Y-axis, starting with the top-ranked stock return. The

CEO pay rank is on the X-axis, starting with the highest-paid CEO. The resulting data plot is al-

most purely scattershot, with an R-squared value of .01. In other words, a CEO’s pay rank was

only 1 percent based on the corresponding stock return rank.4

On the other hand, a preliminary review of proxy statements by consulting firm Hay

Group and The Wall Street Journal indicated that more than half of the 2013 compensation

awarded to the 51 CEOs included in the review was tied to their companies’ financial or stock

market performance. 2013 was a booming year for the stock market, yet most productivity

measures were actually down from 2012, and GDP growth was stagnant.While base salaries in-

creased by 1.7 percent in 2013, incentive payments increased by 4 percent and long-term incen-

tive (LTI) grants increased by 3.8 percent. In 2013, more than half of CEO LTIs were made up

of performance awards. Stock options made up 27 percent of the total performance award value.

Top-performing CEOs were well-compensated, as expected, though the bottom-dwellers in the

review saw their cash compensation decline by only 1.1 percent, despite a 20 percent decline in

profitability for their companies. The Utilities sector enjoyed the largest pay increases of any

business sector, with a 15.9 percent increase, although net income in this sector dropped by 0.2

percent. The Financial Services sector saw a 12.9 percent increase, yet net income increased by

15.4 percent.5

In order to attempt to establish a stronger link between pay and performance, companies

have been increasingly rewarding CEOs with long-term incentive plans. These plans are typi-

cally made up of a large stock option payout that is paid over a number of years and is rewarded

after the company has met performance targets that it has set for itself. Some LTIs, like Apple

CEO Tim Cook’s $376 million 2011 stock option award, are simply awarded over time to the

CEO, though in 2013, the Apple Board of Directors modified Cook’s award to be partially based

on performance criteria. While LTIs may be the strongest method of rewarding a CEO for good

performance, the level of pay granted by them is often excessive, even more so if the CEO exer-

cises his or her stock option rights after the company’s stock price has increased. Also, when a

CEO is compensated $378 million one year and slightly more than $4 million the next two years,

it definitely makes it more difficult to establish a consistent connection between pay and perfor-

mance when such a CEO is being evaluated. I have chosen to exclude in my research CEOs who

have received or will receive a large, lump-sum incentive payment for the purpose of con-

sistency.

4 Eric Chemi and Ariana Giorgi, “The Pay-for-Performance Myth”, Bloomberg Businessweek, July 22, 2014. 5 The Wall Street Journal/Hay Group CEO compensation survey 2013.

The increasing reliance on stock-based compensation raises an important question: How

is “performance” defined? While determining the level of CEO pay by net income or share price

may be better than having no performance-based incentives at all, the reliance on stock-based

compensation can lead to too much short-term focus at the expense of a company’s long-term

vision and viability. The late economist Peter Drucker believed that there should be more to the

definition of a CEO’s “performance” than short-term, or even long-term, financial targets.

Drucker composed a virtual “scorecard for management” containing four other criteria:

1. Management should be evaluated on how successfully capital is invested. Drucker noted

that “most managements spend an enormous amount of time on capital appropriations deci-

sions…but amazingly few managements pay much attention to what happens after the capital

investment has been approved.”6 Drucker also stated that smaller investments are not given as

much attention as larger investments, even though these smaller investments can be equally

important when they are combined.

2. Management should be assessed on how effectively it has hired and promoted people.

This belief is in stark contrast to the widespread belief of producing as much as possible with

as little as possible when it comes to the workforce.

3. Management should be evaluated on how it has spurred innovation, research, and de-

velopment. Research and development is often a costly expense for companies. Many com-

panies prefer to generate sales of their products through marketing existing or mildly updated

products.

4. Management should be held accountable for its business planning. Drucker called for

management to ask itself a series of questions:

• Did the things predicted in the plan happen?

• Were they the truly important things?

• Were the goals set the right goals, in light of actual development, both within the business and

in the market, economy, and society?

• Have these goals been attained?

Drucker disapproved of the surge in CEO pay through the 20th century, believing that it under-

mined employee morale. Drucker would be equally disappointed to see that in this decade, com-

panies have been reluctant to hire employees and at least as reluctant to promote them. Modern-

era executives are not truly being paid for performance. If they were, they would be paid for the

performance of their entire company, not just their ability to please the company’s shareholders.

6 Rick Wartzman, “Why ‘Pay For Performance’ Is a Sham”, Forbes, March 26, 2013.

The Conference Board Task Force on Executive Compensation recently produced a list

of guiding principles for how executive compensation can be “appropriately implemented” in or-

der to “restore credibility with shareholders and other stakeholders”.7 These principles are, in or-

der:

1. Compensation programs should be designed to drive a company’s business strategy and

objectives and create shareholder value, consistent with an acceptable risk profile and

through legal and ethical means. To that end, a significant portion of pay should be in-

centive compensation, with payouts demonstrably tied to performance and paid only

when performance can be reasonably assessed.

2. Total compensation should be attractive to executives, affordable for the company, pro-

portional to the executive’s contribution, and fair to shareholders and employees, while

providing payouts that are clearly aligned with actual performance.

3. Companies should avoid controversial pay practices, unless special justification is pre-

sent.

4. Compensation committees have a critical role in restoring trust in the executive com-

pensation setting process and should demonstrate credible oversight of executive com-

pensation. To effectively fulfill this role, compensation committees should be independ-

ent, experienced, and knowledgeable about the company’s business.

5. Compensation programs should be transparent, understandable, and effectively com-

municated to shareholders. When questions arise, boards and shareholders should have

meaningful dialogue about executive compensation.8

In general, the task force believed that executive compensation should be more closely aligned

with firm performance, and recommended a greater usage of incentive-based pay which

measures performance using a number of metrics and targets. Metrics should be used as a yard-

stick for assessing company and executive performance, and should consist of financial metrics

such as return on assets and equity, non-financial metrics such as compliance and quality, and

individual metrics. Performance targets should be realistic and should give the executive a mean-

ingful opportunity to increase earnings as a reward for performance. Also, such compensation

should not over-reward short-term gains at the expense of long-term performance; it should

properly reward both the building of long-term shareholder value and the long-term creation of

value. Compensation committees should be wary of performance results that are out of the ordi-

nary, as they may have been the result of luck over skill. In order to safeguard against such a cir-

cumstance, a committee may choose to withhold or reduce payment for an anomalous result.

7 The Conference Board Task Force on Executive Compensation, March 2009. 8 Ibid.

Compensation committees may also establish stock ownership requirements in order for execu-

tives to hold a “meaningful position in the company’s stock and therefore to align the interests of

the executives with those of shareholders and encourage executives to focus on the longer

term.”9

In order to test the affordability of its executive compensation program, a company’s

compensation committee may examine the percentage of company earnings paid to executives

and ask itself if this level of compensation is fair and reasonable. The committee also may ana-

lyze how the company will pay for its compensation packages without stunting company growth

or restricting liquidity. Furthermore, compensation committees should benchmark their com-

pany’s executive pay to that of its competition.

The controversial pay practices mentioned in principle number 3 refer to forms of execu-

tive compensation seemingly unrelated to performance or excessive in amount compared to other

members of the company. A well-known example of a controversial pay practice is the “golden

parachute”, which is given to an executive when he or she retires from the company or is termi-

nated. The golden parachute became a common form of compensation during the wave of takeo-

vers and mergers in the 1980’s, as CEO’s of companies that were swallowed up by bigger com-

panies were often terminated. In recent years, however, the term “golden parachute” has often

referred to a generous pay package given to a CEO upon retirement. In 2011, USA Today re-

ported that several CEOs had received retirement packages worth over $100 million that year.10

Such a generous benefit for leaving the company, rather than helping it grow, raise red flags in

the mind of the public, both investors and the general population. The golden parachute and

other controversial forms of compensation have contributed to the erosion of trust in public insti-

tutions since the financial crisis of 2008. In general, the Conference Board recommends that

these pay packages be avoided except in cases where “special justification” exists. In those

cases, the justification should be clearly explained to shareholders.

The Conference Board believes that compensation committees must exhibit “credible

oversight”11 of executive compensation. To do this, a committee must think and act like an

owner. This entails the analysis of compensation programs’ costs and benefits. Compensation

committees must also show independence and an understanding of their company’s business.

The committee does not have to be experienced in all fields of executive compensation program

design, but it must be able to understand the information required for making compensation deci-

sions and know where and when to seek advice on compensation decisions.

Whether a compensation package is straightforward or complex, compensation commit-

tees must provide a clear explanation of it. Compensation disclosures should exhibit an under-

9 Ibid. 10 Gary Strauss, “CEOs’ golden parachute exit packages pass $100 million”, USA Today, November 8, 2011. 11 Ibid.

standing of the business and a clear link between performance metrics and company perfor-

mance. Committees should also work directly with shareholders and form a dialogue to “garner

goodwill and trust of shareholders”.12

Similarly to Peter Drucker, Scott J. Wallsten of the Stanford Institute for Economic Pol-

icy Research warned that “without proper incentives, CEOs may not be inclined to act in the best

interests of the shareholders. A CEO paid a flat salary, for example, may pursue goals other than

maximizing firm value - at potentially enormous cost to the shareholders.13 Executives may fo-

cus on performance measures during periods when they are being evaluated for performance, but

although the timing of sales during the year can be adjusted to the benefit of executives, the tim-

ing of profits does not change, and the amount to which executives can “game” their compensa-

tion is small relative to their overall compensation.14 Wallsten also suggests that the link between

executive compensation and firm performance is stronger during times of growth, and the pay-

performance link also increases the higher one scales the corporate ladder. Wallsten gathered

data for his analysis from the Standard & Poor’s Execucomp database containing compensation

data on top executives and financial data on their firms from 1991 to 1995. Wallsten’s data

showed that executives who saw their firms’ market value increase saw increases in their com-

pensation, while executives who saw their firms’ market value decrease saw, at worst, no in-

crease in compensation. Similarly, Hallock (1998) concluded that CEOs do not receive raises

when layoffs are announced. While CEOs are often punished for layoffs, the study found that the

punishment is small enough to not deter future layoffs.15 This illustrates a disconnect between

how CEOs get paid and how everyone else gets paid. When the “common man” exhibits poor

performance at his job, he risks being fired and losing most, if not all, of his income. When a

CEO fails to properly manage his or her company, the “penalty” is no increase in pay, or maybe

a small increase in pay. It is very rare for a CEO to have his or her compensation decreased un-

less that CEO is voluntarily restricting his or her salary. Furthermore, it takes a lot for a CEO to

get fired, and once out of a job, it is far easier for CEOs to pull themselves up by their bootstraps

and find new employment. CEOs also enjoy larger pay increases relative to their firm’s market

value. Wallsten found that top executives in his data group received an additional 13 cents for

every $1,000 increase in firm value, while second-ranked executives received an additional 6

cents for every $1,000 increase in firm value.16

12 Ibid. 13 Scott J. Wallsten, “Executive Compensation and Firm Performance: Big Carrot, Small Stick, Stanford Institute for

Economic Policy Research, March 2000. 14 Kevin F. Hallock and Paul Oyer, “The Timeliness of Performance Information in Determining Executive Com-

pensation”, December 1, 1999. 15 John M. Abowd and David S. Kaplan, “Executive Compensation: Six Questions That Need Answering”, National

Bureau of Economic Research, May 1999. 16 Scott J. Wallsten, “Executive Compensation and Firm Performance: Big Carrot, Small Stick”, Stanford Institute

for Economic Policy Research, March 2000.

There is more research that suggests incentive-based executive pay has a positive effect

on a firm’s performance. Masson (1971) found that firms that provided greater incentives for

their CEOs enjoyed stronger stock returns in the period following World War II. Larker (1983)

observed positive stock reactions following a firm’s adoption of a short-term incentive plan

based on single-year performance measures. Leonard (1990) found that companies with LTI

plans showed greater return on equity than companies without LTI plans.17

Other research suggests that there is no correlation between executive compensation and

firm performance. Chris (2008) found a lack of a connection between pay and performance in the

banking industry. Also in 2008, D.M. Trudy suggested that there is no relationship between pay

and performance in the airline industry. O’Donnell (2007) suggested that the link between pay

and performance diminishes with an increase in executive compensation. Referring to an earlier

study on the relationship between a non-profit organization’s performance and executive com-

pensation, O’Donnell found that non-profit organizations do a better job of paying their execu-

tives according to the organization’s returns, earnings, assets, and stock performance than for-

profit companies do.18

Gary F. Keller of Eastern Oregon University believes that “the issue of determining if a

CEO’s annual compensation is directly correlated to yearly increases or decreases in enterprise

value is a topic that few outside the boards of directors’ corporate compensation committees

clearly understand”.19 Keller found no statistically significant correlation between the compensa-

tion of the executives of 48 publicly traded firms in Wisconsin and the net incomes and stock

prices of their firms in 2008. However, in 2010, Keller found a statistically significant correla-

tion using the same 48 firms in his research.

A recent research project conducted by academics from Stanford University, the Univer-

sity of California, and Santa Clara University points out that narcissism is a common trait among

CEOs, as individuals with the traits of narcissism, such as dominance and self-confidence, often

emerge as leaders. According to this project, CEOs with high levels of narcissism are compen-

sated more generously than a “normal” CEO, and the level of compensation increases the longer

a narcissistic CEO stays at a firm. Also, the level of inequality between CEO and worker com-

pensation is greater in the case of the narcissistic CEO. Their “tendency to be self-serving, ex-

ploit others, and have low empathy”20 enables them to “extract” higher levels of compensation

from their boards of directors. While narcissistic leaders can exhibit a strong sense of control

17 John M. Abowd and David S. Kaplan, “Executive Compensation: Six Questions That Need Answering”, National

Bureau of Economic Research, May 1999. 18 Adil Waseem, “Is US executive compensation Model flawed?”, URL www.adilwaseem.com. 19 Gary F. Keller, “Evaluating if a Linkage Exists Between CEO Compensation and the Net Income and Stock Price

of Their Firm: A Micro Study.”, Annual International Conference on Business Strategy & Organizational Behaviour

(BizStrategy), 2013, p81-86. 20 Charles A. O’Reilly III, Bernadette Doerr, David F. Caldwell, Jennifer A. Chatman, “Narcissistic CEOs and exec-

utive compensation”, The Leadership Quarterly, August 7, 2013.

over both the company and their own emotions, and they can motivate their subordinates through

their charisma and transformational leadership, they are less likely to engage in pro-social organ-

izational behavior, are more likely to cheat and violate ethical standards, are more likely to leave

their employees unhappy, and are more likely to reject and ignore criticism. The Stanford-Cal-

Santa Clara group used these attributes to label CEOs as narcissistic, and collected data on the

personality of CEOs from 54 publicly traded tech firms in the United States, using ratings from

company employees and executive compensation from these firms for 2009.21

In a 2010 staff report, the Federal Reserve Bank of New York suggested that executives

can be compensated in the form of deferred compensation and pension benefits, which have

debt-like characteristics, as an incentive for the CEO to take less risk.22 Equity-based compensa-

tion, on the other hand, encourages the CEO to be more risky through attempting to maximize

short-term gains in order to boost the value of the CEO’s equity-based compensation package.

The New York Fed also recommends that credit-default swaps be part of a CEO’s compensation

as a risk-minimizing measure. In the staff report’s conclusion, the Fed explains that “the CDS

provides a market price for risk, which, when weighted correctly in a compensation contract that

includes an equity component, can provide first best risk incentives…while other debtlike instru-

ments are available, basing compensation on the CDS spread is likely to be (i) cheaper, because

it does not need to be deferred and (ii) easier to implement, because it is relatively more liq-

uid”.23

The field of academic research, in conjunction with print and online publications as well

as institutions like the Federal Reserve Bank of New York, has thoroughly documented the

strength of the correlation between pay and performance and the reasons why executives are paid

they are. Another important source of information on executive compensation is the proxy state-

ment. The proxy statement, also known as Form DEF 14A, is filed with the U.S. Securities and

Exchange Commission. The main purpose of the proxy statement is to allow shareholders to ex-

ercise their voting rights via proxy. Shareholders often vote via proxy, as most shareholders do

not attend shareholders’ meetings. Shareholders vote on electing directors and approving or re-

jecting major transactions, including changes in executive compensation. The proxy statement of

every company includes a section on executive compensation, which includes a summary com-

pensation table outlining how much top executives were paid over the last three years and how

they were paid, breaking down each executive’s compensation by salary, bonuses, stock awards,

non-equity compensation, other compensation, and total compensation. The proxy statement also

discusses in detail how executive compensation is determined. Ford Motor Company’s 2014

proxy statement includes a subsection of the executive compensation section titled “How We

21 Ibid. 22 Patrick Bolton, Hamid Mehran, and Joel Shapiro. “Executive Compensation and Risk Taking”. Federal Reserve

Bank of New York Staff Reports, no. 456, June 2010; revised November 2011. 23 Ibid.

Determine Compensation”. The first part of this subsection is Ford’s compensation and benefits

philosophy, which is simply rewarding executives for performance and “contributions to busi-

ness success” with a package that “will be competitive with leading companies in each coun-

try”.24 Next, Ford issues a “strategy statement” of attracting, retaining, and motivating employ-

ees through compensation, which will consist of developed benefit programs that promote these

objectives while minimizing long-term liabilities. Ford also has a series of guiding principles, as

follows:

1. Performance Orientation. Ford believes that “compensation programs should support and

reinforce a pay-for-performance culture”25 and should provide executives with the proper mo-

tivation for achieving the desired results, as well as provide income security and protection

from catastrophic losses.

2. Competitive Positioning. Ford believes that competitive levels of executive compensation

are necessary in order to attract the best and brightest individuals available. Ford uses the av-

erage level of compensation of automotive and other top national companies as a benchmark

in setting its own level of compensation.

3. Affordability. Compensation and benefits must not be so excessive as to be unaffordable to

the company in the medium-to-long-term. Compensation programs should stay relatively

consistent and should not fluctuate significantly in order to boost Ford’s short-term perfor-

mance.

4. Desired Behaviors. Ford believes that executive compensation should promote “desired be-

haviors” and support the company’s business objectives.

5. Flexibility. Compensation programs should be individualized where appropriate.

6. Consistency and Stability. While compensation programs may be tailored to individuals,

these programs should be consistent between Ford divisions worldwide, as far as pay levels

are concerned.

7. Delivery Efficiency. Compensation programs should be understandable and implementable

in a consistent, equitable, and efficient manner. Programs should be “tax-effective to the

Company and employees as far as practicable”.26

8. Delivery Effectiveness. Clearly defined performance metrics should be created for compen-

sation programs, and these metrics should be used to continuously improve the business.

As mentioned in principle number 2, Ford sets a target level of executive compensation based on

the compensation levels of major American companies. In December 2012, Ford’s executive

compensation committee analyzed a report on Ford’s compensation programs. The report was

based on information from the Towers Watson Executive Compensation Database. The commit-

24 Ford Motor Company 2014 proxy statement. 25 Ibid. 26 Ibid.

tee found that Ford’s 2013 compensation balance between salary and incentives was almost per-

fectly in line with the average of the survey group. 20 percent of Ford’s executive compensation

was allocated to salaries and other compensation, another 20 percent was allocated to Ford’s tar-

get for incentive bonuses, while the remaining 60 percent was used for long-term incentives. The

survey group averaged 19, 18, and 63 percent for their respective categories.27

Ford also includes in its executive compensation portion of its proxy statement a section

titled “What We Pay and Why We Pay It”. The section starts with a summary compensation ta-

ble. The left side of the table organizes the elements of Ford’s executive compensation by fixed

and performance-based compensation and further breaks down its compensation into base salary,

retirement plans, benefits and perquisites, annual cash incentive awards, and long-term incentive

awards. The right side of the table lists the reasons for providing these elements of compensa-

tion. Boxes in the table are dotted or left blank according to whether an element of compensa-

tion corresponds with a reason or reasons for each element. For example. the table shows that

Ford’s reason for providing benefits and perquisites is to enhance executive productivity.28

In addition to setting a general executive compensation target, Ford sets incentive bonus

targets for each of its four top executives as a percentage of their salary. The target incentive bo-

nus compensation percentage for these executives is based on each individual’s “level of respon-

sibility, competitive compensation data, pay equity considerations among the executive officers,

past target amounts, as well as the need for flexibility to motivate and reward exceptional perfor-

mance while maximizing the deductibility of compensation by following the shareholder ap-

proved terms of the Incentive Bonus Plan”.29 Ford also pays incremental bonuses beyond incen-

tive bonuses earned in a performance year where the executive compensation committee deems

it appropriate. Ford’s equity-based compensation is tied to the performance and future value of

its common stock and are meant to incentivize executive focus on long-term business interests.

Ford also requires stock ownership goals for executives at or above the Vice President level. The

ownership goal starts at 100% of the Vice President’s salary and increases with each level of po-

sition, with the CEO’s ownership goal being 600% of his salary.30

Despite all of these justifications for executive compensation, the correlation between ex-

ecutive compensation and firm performance is still lacking, as there is more to the meaning of

performance than financial data can indicate. The next section of this research paper seeks to

back up this hypothesis.

In order to determine the link between executive compensation and firm performance, if

there is any, I have compiled a database of 20 companies listed on the S&P 500 index. These 20

companies are split into 8 groups of competitors:

27 Ibid. 28 Ibid. 29 Ibid. 30 Ibid.

1. Food/Beverage: Coca-Cola Enterprises, PepsiCo, Dr Pepper Snapple Group

2. Automotive: Ford Motor Company, General Motors

3. Communications: Sprint, AT&T Inc., Verizon Communications

4. Athletic Apparel: Nike, Under Armour

5. Casual Apparel: Urban Outfitters, The Gap, Inc.

6. Banking: Bank of America Corp, BNY Mellon, JPMorgan Chase & Co.

7. Cable Television: Cablevision Systems Corp., Comcast Corp., Time Warner Cable Inc.

8. Tobacco: Altria Group Inc, Reynolds American, Inc.

Table 1: Net income vs. CEO total and stock-based compensation for 20 S&P 500-listed

companies, 2013.

For each company, net income is compared to a CEO’s total compensation as well as stock-

based compensation. Net income totals for each company were gathered from the company’s

SEC Form 10-K, while compensation figures are from the company’s Form DEF 14A. The com-

pany list as well as income and compensation data was organized on the above Microsoft Excel

spreadsheet, from which the income and compensation data was sent to an online multiple re-

gression calculator,31 from which two regression plots were constructed. Net income is the con-

stant between both plots, with the first plot comparing net income to total CEO compensation

31 Wessa P., Multiple Regression (v1.029) in Free Statistics Software (v1.1.23-r7), Office for Research Development

and Education, URL http://www.wessa.net/rwasp_multipleregression.wasp/

Company Net Income CEO Total Comp. Stock-Based Comp. % Stock-Based

Coca-Cola Enterprises 667000000 20380660 13513934 66.31%

PepsiCo 6740000000 14280877 7458225 52.23%

Dr Pepper Snapple Group 624000000 9052569 5999951 66.28%

Ford Motor Company 7155000000 23204534 17737486 76.44%

General Motors 5346000000 9071309 7302206 80.50%

Sprint -1860000000 49077699 34073707 69.43%

AT&T Inc. 18553000000 23247167 13441558 57.82%

Verizon Communications 11500000000 15826606 9375077 59.24%

Nike 2693000000 14678349 5951198 40.54%

Under Armour 162330000 3188488 784226 24.60%

Urban Outfitters 282360000 68487 5000 7.30%

The Gap, Inc. 1280000000 18726912 14200512 75.83%

Bank of America Corp 11431000000 13139357 11142643 84.80%

BNY Mellon 2192000000 9450775 4682101 49.54%

JPMorgan Chase & Co. 17923000000 11791833 10000000 84.80%

Cablevision Systems Corp. 338316000 15987539 3535542 22.11%

Comcast Corp. 6816000000 31367254 10590000 33.76%

Time Warner Cable Inc. 1954000000 32501715 16024826 49.30%

Altria Group Inc 4535000000 15407467 5398800 35.04%

Reynolds American, Inc. 1718000000 10452206 6599869 63.14%

and the second plot comparing net income to a CEO’s stock-based compensation. The results are

as follows:

1. Net Income vs. CEO Total Compensation

While the 20 companies in this study are all well-known, there was still a wide disparity

in the companies’ net income. In fact, Sprint recorded a net loss for 2013 totaling $1.86 billion.

The biggest earner was rival AT&T, with a net income of more than $18.5 billion. In fact, there

is a relatively large gap in income between the companies in each of the eight industries repre-

sented, save the auto industry, where Ford and General Motors are very competitive with each

other and have been since 2009, when GM began its U.S. government-aided reconstruction fol-

lowing its bankruptcy and Ford, with plenty of cash on hand, was able to survive the financial

meltdown and global recession without any government assistance.

Total CEO compensation amongst the 20 companies also varied greatly. Urban Outfit-

ters’ CEO was the lowest-paid by a big margin, taking home $68,487 in 2013. The second-low-

est-paid CEO in the group, at $3.19 million, was the CEO of Under Armour. Interestingly, the

CEO of Sprint was the highest-paid, at over $49 million. The median CEO compensation of the

group was just over $15 million.

The equation relating corporate income to CEO compensation is as follows:

Net_Income[t] = + 5262220000 -15.6405CEO_Total_Compensation[t]

+ 654575t + e[t]

The t-statistic of -0.1226 and p-value of 0.451938 of the CEO_Total_Compensation variable in-

dicate a lack of correlation between the net income and total compensation values. While the t-

statistic is negative, indicating an inverse relationship between net income and total CEO com-

pensation, it is so insignificant in value that it may have been positive had one or two different

companies been used in the sample. The R-squared value is 0.00172123, meaning that CEO

compensation was little more than one-tenth of one percent based on corporate income.

Graphs - Net Income vs. CEO Total Compensation

Fig. 1: Residuals (difference between each value and sample mean) for the 20 companies in

Table 1.

Fig. 2: Residual histogram categorizing the residual values into 5 groups, with the number

of income values falling into each group listed on the y-axis.

Fig. 3: Residual Lag plot, lowess, and regression line. The residual values, shown as dots, are

scattered across the plot with no discernible pattern, showing that the residual data points are

completely random and independent from each other. The lowess curve (in this case, shaped like

a mountain peak on its left side) is shaped in the form of the distribution of the residuals. The re-

gression line is the downward-sloping line and is the “slope” of the net income-total compensa-

tion equation.

Fig. 4: Residual normal Q-Q plot comparing the net income values in Table 1 with stand-

ardized values ranging from -2 to 2. The data points on the plot are randomly scattered, indi-

cating abnormal distribution.

Fig. 5: Resid-

ual diagnos-

tics.

a. Resid-

uals vs. Fitted: a plot of

residual data

values

against fitted values, with a best-fitting line in red

showing the trend of the data movement.

b. Normal Q-Q: see Fig. 4.

c. Scale-Location: a plot of the square root of standardized residuals against the same fitted

values of graph 5a, also with a best-fitting line in red.

d. Residuals vs. Leverage: a plot of standardized residuals against “leverage”, which is a

measure of the influence that a data point has on the regression relationship. The dotted red

lines represent Cook’s distance, which measures the effect of deleting a given data point.

2. Net Income vs. CEO Stock-Based Compensation

Is the relationship between net income and a CEO’s stock-based compensation any more signifi-

cant? The equation relating net income to CEO stock-based compensation is as follows:

Net_Income[t] = + 12818500 + 3.90969e-

05CEO_Stock_Compensation[t] -297448t + e[t]

For the CEO_Stock_Compensation variable, the t-statistic of 0.1299 is nearly a mirror of the

CEO_Total_Compensation variable’s t-statistic, while the p-value of 0.449083 is almost identi-

cal to the p-value of CEO_Total_Compensation. The R-squared value is 0.0567828, indicating at

least a minimal correlation between net income and stock-based compensation.

The amounts of stock-based compensation that the 20 CEO’s in the group received was,

like the amount of total compensation, highly variable. The CEO of Urban Outfitters received

$5,000 in stock pay, by far the lowest amount. Sprint’s CEO received the highest amount of

stock-based compensation, with a total of over $30 million. However, several other CEO’s in the

group received a greater percentage of their compensation in stock-based pay. The CEO’s of

Bank of America Corp. and JPMorgan Chase & Co. both received 84.8% of their pay in stocks,

options, and other stock-based incentives. Interestingly, the CEO of fellow banking firm BNY

Mellon was granted stock-based compensation totaling less than half of his total pay. It is indi-

cated in BNY Mellon’s 2014 proxy statement that the CEO, Gerald Hassell, was not granted any

amount of stock options in 2013. The proxy statement also indicated that Mr. Hassell had options

in his possession that have not yet been exercised.32 The CEO of Urban Outfitters was given the

lowest percentage of stock-based compensation in the group, at 7.3%, although the amounts of

both his total and stock-based compensation are insignificant relative to the rest of the group.

Otherwise, the CEO of Cablevision Systems Corp. received the lowest level of stock-based com-

pensation, percentage-wise, at 22.11%.

32 BNY Mellon 2014 proxy statement.

Graphs - Net Income vs. CEO Stock Compensation

Fig. 1: Residuals (difference between each value and sample mean) for the 20 companies in

Table 1.

Fig. 2: Residual histogram categorizing the residual values into 5 groups, with the number

of income values falling into each group listed on the y-axis.

Fig. 3: Residual Lag plot, lowess, and regression line. Again, the plot is scattered with no dis-

cernible pattern.

Fig. 4: Residual normal Q-Q plot comparing the net income

values in Table 1 with standardized values ranging from -2 to 2. Again, the data points on the

plot are randomly scattered,

indicating abnormal distribution.

Fig. 5: Residual diagnostics.

This study is not meant to be completely comprehensive, having limitations like all other

forms of research of this subject. First, the data collected for this study encompasses only a sin-

gle year, or, more specifically, the respective fiscal years for each company. Other studies have

spanned multiple years or even decades. Also, other studies have included more companies than

the 20 that have been included in this study. The 20 companies are all publicly listed on the S&P

500, which means they are relatively large companies. Other studies may choose a sample of

smaller companies, in which case the levels of CEO compensation and net income are likely to

be smaller, and CEO’s are less likely to be rewarded after a year of relatively weak net income,

or a net loss. Finally, along with limiting my sample to 20 companies from one listing index and

a period of one year, I limited my variables to net income, total compensation and stock-based

compensation in order to achieve direct and comparable results. I considered using 2013 stock

returns as my performance variable, but it was not directly comparable with CEO compensation,

as the latter is calculated over the fiscal year, rather than the calendar year. Other possible varia-

bles that could have been implemented include return on assets, return on equity, and total com-

pany valuation. Political and economic issues certainly play a part in executives’ decisions re-

garding capital investment, hiring, and firing, among others, as documented in the Business

Roundtable’s CEO Economic Outlook Survey for the fourth quarter of 2014. The Roundtable,

which represents the CEO’s of America’s largest companies, has suggested that Congress must

act to extend tax incentives that are set to expire on January 1, 2015.33 Uncertainty over federal

tax policy has rendered American companies hesitant to make significant capital investments,

stunting economic growth in the process. Macroeconomic Advisers, a forecasting firm, has cal-

culated that previous Congressional fiscal policy, including budget cuts and the manufactured

crisis over raising the nation’s debt limit, cut as much as 1 percent from U.S. economic growth

since 2011, which is very significant, considering that average economic growth since then has

been just 2.15 percent.34 What is not documented by the Roundtable’s survey is the effect that

political and economic issues have on CEO pay.

Previous research, as well as the research described in this paper, has failed to establish a

strong connection between executive compensation and firm performance. While it is possible to

establish a strong connection between these two variables, such a connection exists in an isolated

case, such as Tesla Motors, who will pay its CEO, Elon Musk, a whopping $78.1 million over 10

years, providing Mr. Musk meets his specified performance targets. In 2013, Mr. Musk was paid

a total of $69,989.35 Even when CEO’s are justifiably paid for their performance, the amount of

compensation awarded often seems arbitrary, rather than being an objective calculation based on

33 Business Roundtable, “CEO Economic Outlook Survey Q4 2014”. 34 Jonathan Weisman, “Uncertainty in Washington Poses Long List of Economic Perils”, The New York Times, De-

cember 2, 2014. 35 Tesla Motors 2014 proxy statement.

net income or other measures of firm performance. When taking into account a large sample of

firms, whether public or private, S&P 500, Dow Jones, or NASDAQ-listed, or large or small, a

definite link between pay and performance has not yet been established. However, the link be-

tween executive compensation and firm performance may strengthen in the future, as the pres-

sure on companies to justifiably compensate their leaders has increased since the financial crisis

of 2008. Most people do not expect CEO’s to be paid at a level anywhere close to the average

worker, but they are at least expected to earn their pay like the rest of the working world.