CEO firm specific wealth change and firm performance: An empirical pay-­‐performance study within public listed Danish companies from 2004-­‐2010

Casper Freltoft Junge & Joel Astrup Madsen

Student thesis: Master thesis


Taking its starting point in the classical principle-agent theory this study is the first paper to provide an extensive review of the compensation practices in Danish listed companies from 2004-2010. The goal of this study is to establish if a relationship exists between CEO pay and performance. We adopt a more sophisticated notion of CEO compensation by including the ongoing change in wealth that arises from changes in the value of the CEOs portfolio of stocks and options, as well as transactions within this portfolio. CEO wealth change is then linked to shareholder return (a proxy for firm performance) mainly through regression analysis. In the analysis we rely on three different statistics widely used in the existing pay-performance literature, namely: the Jensen & Murphy statistic (sensitivity), equity at stake, and elasticity. In addition to the regression analysis we construct the delta of each CEOs portfolio of stocks and options for each year in order to be able to make inferences about their incentive structure going forward. The study incorporates extensive information about CEO compensation and the development in stocks and options holdings over the entire period in Danish companies. All the information has been gathered manually from the firms’ annual reports and insider notifications, involving approximately 400 hours of data collection. The final sample includes 66 companies. On the basis of an extensive literature review nine hypotheses about the level and structure of total compensation as well as the pay-performance relationship is constructed. The hypotheses are tested on our results and the main conclusion is that a significant relationship does exist, however small in economic terms. We further find that no relationship exists when only looking at Small Cap companies, and that no relationship exists between CEO pay and relative performance. The implications are extensive since a lacking pay-performance relationship is likely to lead to agency costs, and thereby loss of shareholder value. As a result we strongly advise Danish listed companies to reevaluate their compensation practices and try to focus on enhancing the payperformance relationship. This should be done in a way that shifts part of the fixed salary towards variable equity-based compensation in order to make sure that the CEOs are co-investing. Additionally when possible they should be designed to reflect relative performance, as it is a better proxy for the CEOs actual performance, excluding market and industry effects.

EducationsMSc in Applied Economics and Finance, (Graduate Programme) Final Thesis
Publication date2011
Number of pages177