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Relevance of Past Performance Measures in Chief Executive Compensation
Rajiv Banker, Temple University
Rong Huang, City University of New York - Baruch College
ABSTRACT. Prior studies of pay-for-performance have focused on the relationship between total compensation and contemporaneous performance contingent on agent’s effort. In contrast, we focus on the use of measures of past performance. Consistent with the notion that past performance provides signals about the agent’s innate ability, we find that salary--the fixed component of total compensation is positively related to past performance. This finding supports the theoretical prediction of such use to address the adverse selection problem. In a moral hazard setting, measures of past performance are useful as benchmarks to filter out the noise when incentive pay is based on contemporaneous performance. Consistent with this prediction, we find that bonus--the contingent part of total compensation is negatively related to past performance. Our results suggest the importance to consider both contemporaneous performance and past performance and to investigate fixed pay separately from contingent pay.
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