Executive Compensation and Corporate Performance in Electric and Gas Utilities

By Agrawal, Anup; Makhija, Anil K. et al. | Financial Management, Winter 1991 | Go to article overview

Executive Compensation and Corporate Performance in Electric and Gas Utilities


Agrawal, Anup, Makhija, Anil K., Mandelker, Gershon N., Financial Management


* Recent studies on public utilities do not find a positive relationship between managerial compensation and corporate profitability (see Hirschey and Pappas [16], and Carroll and Ciscel [9]). This literature interprets these findings as suggesting that incentives for profitability are not needed in public utilities, since regulation provides assured profits. However, there are at least three reasons to cast doubt on these findings.

First, these studies examine the pay-performance relationships for managers across different firms. Economic theories of incentive contracting suggest than an efficient contract should reward managers based on factors such as managerial ability, managerial responsibility, firm size and past performance, in addition to current performance. Murphy [27] argues that in the absence of a theory specifying the relevant observable variables, cross-sectional models of pay-performance relationships are subject to a serious omitted-variables problem. However, if these omitted factors do not change over time for individual executives, we can correctly assess the pay-performance relationship by analyzing time-series regressions for individual executives. Recent studies on unregulated firms find a strong positive relationship between managerial compensation and stockholder returns (see, e.g., Benston [5], Coughlan and Schmidt [12], Murphy [27], and Antle and Smith [2]). These findings contrast with earlier studies on unregulated firms that use a cross-sectional approach and find, at best, a weak relationship between executive compensation and firm profitability (see, e.g., Ciscel and Carroll [11] for a survey). These studies support similar claims in the popular press (see, e.g., Loomis [23]).

Second, most of the studies on public utilities confine their attention to only part of the compensation package, usually salary and bonus, rather than examining the total pay package. This approach ignores potentially performance-sensitive pay components, such as contingent or deferred remuneration, and stock-related incentive plans. Third, most of these studies use accounting-based performance measures, which tend to be historical rather than forward-looking.

This paper reexamines the relationship between top executive compensation and corporate performance in public utilities by applying new methodologies that directly address these problems. Our findings are mostly consistent with the hypothesis that senior managers are rewarded for pursuing stockholder wealth maximization.

Section I reviews the pertinent literature and develops the testable hypotheses. In Section II, we present our methodology. The data is described in Section III. The results of our analysis are in Section IV. Some additional tests are described in Section V. We conclude in Section VI.

I. Previous Research on the

Pay-Performance Relationship

for Top Managers

The issue of managerial behavior in the unregulated firm has been extensively debated. In one view, the separation of ownership from control allows managers to pursue self-serving goals that may not benefit stockholders (Berle and Means [6], Jensen and Meckling [18], and Jensen [17]). Managers are seen to seek job security, perks, prestige, and control rather than stockholders' welfare. Baumol [3] and [4], and Marris [25] suggest sales maximization as the primary managerial objective, since growth in sales is likely to result in a larger firm and increase prestige and possible perk consumption. (1) They argue that compensation plans, proposed and adopted through managerial influence, reflect these goals. According to this view, there is a positive relation between compensation and growth in sales. Furthermore, according to some, (e.g., Loomis [23]), there is no link between compensation and profitability. We will refer to this view as the sales maximization hypothesis.

An alternative view holds that competitive market forces, as well as managerial compensation contracts, tend to align the interests of managers with those of stockholders. …

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