Boards of Directors, CEO Ownership, and the Use of Non-Financial Performance Measures in the CEO Bonus Plan

Authors


*HEC Montréal, 3000 Ch. de la Côte-Sainte-Catherine, Montréal, Quebec, Canada H3T 2A7. Tel: 514-340-6516, Fax: 514-340-5633, E-mail: eduardo.schiehll@hec.ca

ABSTRACT

Manuscript Type: Empirical

Research Question/Issue: This study examines the associations between the board of director's choice to integrate non-financial performance measures into the CEO bonus plan and two other governance mechanisms – board independence and CEO ownership – in a sample of publicly traded Canadian firms.

Research Findings/Results: The results provide evidence that the use of non-financial performance measures in the CEO bonus plan varies predictably. Growth opportunities are positively associated with the firm's choice to integrate non-financial information into the CEO bonus plan. The results are also sensitive to our proxy for board independence and CEO ownership in firms with high growth opportunities.

Theoretical Implications: Agency theory states that any costless performance measure providing incremental information about the agent's effort will improve the efficiency of the contract with the agent. In contrast with most of the literature in this area, which investigates pay-performance sensitivity and governance structure, we examine an important component of pay-for-performance plans used to align and compensate executive actions that might not be reflected in traditional financial performance measures.

Practical Implications: This study documents that boards choose performance measures that best reflect the CEO's contribution to firm value, taking into account the firm's monitoring environment. This study therefore has policy implications regarding the need for enhanced disclosure of CEO compensation to improve investor understanding of the alignment between executive pay and firm performance.

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