ESSAYS ON EXECUTIVE COMPENSATION AND MANAGERIAL …

ESSAYS O N EXECUTIVE COMPENSATION

AND MANAGERIAL INCENTIVES

Xianming Zhou

A thesis submitted in conformity with the requirements for the degree of Doctor of Philosophy Graduate Department of Economics University of Toronto

o Copyright by Xianming Zhou 1997

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Essays on Executive Compensation and Managerial Incentives

Xianming Zhou Doctor of Philosophy 1997 Graduate Department of Economics

University of Toronto

Abstract

The first chapter of this dissertation examines the regdatory impact of executive compensation disclosure on managerial pay schemes. Analysing a three-level agency mode1 arnong the shareholders, directors, and manager of a firm, this chapter shows that before disclosure, the directors may underinvest in monitoring the manager's activities because of asymmetric information on the penomance of the directors and a divergence of interests between them and other shareholders. Compensation disclosure rules mitigate this ineficiency and increase the pay-performance linkage. Empincaily, this chapter examines the impact of compensation disclosure by comparing the sensitivity of C E 0 pay to finn performance, before and after the new Ontario disclosure regulation (1993),between groups of firms that were differentidly afEected by the legislation. It is found that after introducing the Ontario regulation, the pay-performance sensitivity increased much more in the firms that were affected by the regulation than in those that were unaffected by the regulation. In contrast to previous studies, these findings suggest that disclosure of executive compensation strengthens the pay-performance

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relationship. The second chapter provides the first systernatic examination of the relationship between

CE0 compensation. fimi size, and corporate performance for Canadian f m . Consistent with previous studies, this chapter fmds that C E 0 pay rises with fm size and that compensation

is tied to Company performance. Some novel fmdings are also documented. First, options and stock ownership tend to play a relatively more important role for CE0 incentives in small firms. And second, while C E 0 turnover probability is generally negatively related to the firm's stock performance, the threat of dismissal is less pronounced in small firms.

The third chapter compares executive pay-performance sensitivities between Canadian firms and US firms. Examining the data for 365 Canadian h s and 678 US f m s over the years

1991-1994, it is found that the pay-performance sensitivity associated with direct pay and stock

ownership is smailer in Canadian fimis than in US firms but that the difference diminishesas firm size increases. This finding, together with poorer corporate performance and lower C E 0 pay of Canadian firms, is consistent with the hypothesis that managerial incentives affect firm

Acknowledgements

1 would like to thank Dwayne Benjamin, Morley Gunderson, Michael Berkowitz, and Michael Baker for their comments and encouragement. Specid thanks go to Aloysius Siow who paid close attention to my progress, spent countless hours discussing various issues with me and provided many valuable suggestions. I am especially grateful to my supervisor. Arthur Hosios, for his guidance and inspiration, his constructive criticism and insighdul suggestions at every stage of my research, and for his effort in the many revisions of this dissertation. Finally, 1want to express my gratitude to my farnily to whom 1dedicate this work.

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