Incentive for More? An Empirical Study on the Use of Performance Measures In Relation to Incentive Pay of Leaders in Danish Companies

Hans Junker Petersen & Jonas Led Hansen

Student thesis: Master thesis

Abstract

This thesis examines whether theoretical motives for specific performance measures support the composition of incentive schemes in Danish companies. Based on Principal-Agent theory performance pay is considered part of the solution to the possible conflict between shareholders and executives. Through a comprehensive theoretical examination of specific performance measures, the efficiency of each type is evaluated based on four criteria: congruence (i.e. alignment of interests), controllability, simplicity and issues related to accounting and tax. A survey on the use of performance pay, carried out in larger Danish companies, forms the framework for an analysis of: 1) which performance measures are used and why, and 2) which company specific factors affect the selection of performance measures and thus the overall composition of incentive schemes. It is concluded that the theoretical motives, to some extent, form the basis for the actual use of performance measures; however there is room for improvement. The general practice is that simplicity and congruence are emphasized when selecting performance measures. The particularly high priority of simplicity means that a complete solution to the principal-agent problem, which requires complete congruence, is not achieved. However the analysis suggests that congruence in the performance measures can be significantly improved without decreasing simplicity; particularly for capital intensive companies. Also it is suggested that when pay is based on stock return, regular shares are both simpler and more congruent than share options or warrants. This is primarily due to the alignment of risk between executives and shareholders. Thus, the principal-agent problem can, to a greater extent, be limited by more precisely aiming performance measurement towards value creating activities and securing risk alignment between executives and shareholders. Finally the thesis presents three recommendations in relation to performance measurement: 1) Aim measurement at value creating activities in relation to capital intensity, 2) use regular shares when basing pay on stock return and 3) consider economic profit measurements as alternatives when measuring long term value creation.

EducationsMSc in Finance and Accounting, (Graduate Programme) Final Thesis
LanguageDanish
Publication date2017
Number of pages148