Relationship between CEO Compensation and Firm Performance in European Companies

According to the agency theory, CEO compensation is one of the pivotal instruments, which serve to align managers’ and shareholders’ interests. The problem is the discrepancy between theory and reality observed in empirical literature on executive pay. In this study, we seek to examine, whether CEO remuneration is performance-sensitive and whether companies that pay their CEOs more perform better. Our analysis, in which we treat both compensation and firm performance as endogenous, is based on the sample of approximately 350 European firms for the period from 2009 to 2013. The findings suggest that CEO compensation is positively associated with corporate performance either market- or accounting-based. Nevertheless, simultaneous estimation of compensation and performance equations revealed that CEO pay positively influences only corporate operational results and has insignificant impact on stock efficiency. Overall, our findings are partially consistent with real practices since most companies design compensation contracts as a function of accounting-based results.