CEO compensation, leverage and corporate board of directors, and their joint impact on performance

This dissertation examines the relationship of CEO's incentive compensation structure with the firm's leverage and corporate board independence, and the joint impact of the three governance mechanisms on firm performance. Most prior empirical related research ignores the endogeneity of managerial compensation and the above listed factors, and accordingly, report empirical results that are not consistent. Specifying a simultaneous-equations model to recognize the endogeneity engendered, I analyze 924 firms over 1992--2000 period. I find that cross-sectionally the sensitivity of managerial compensation to performance is correlated with the leverage ratio of firms. This result is consistent with the theoretical implication of Haugen and Senbet (1981) and Grinblatt and Titman (1989). However, this positive relationship exists for CEOs with low level of share ownership, but not for the CEOs with high level of share ownership. That is, corporate capital structure is nonlinearly related to CEO's pay to performance sensitivity across firms. In addition, our panel data analysis indicates that temporally the CEO's pay-sensitivity is reduced with an increasing debt ratio, supporting the theoretical prediction of John and John (1993). I also demonstrate that the management pay-performance sensitivity and board independence are negatively related with each other, suggesting the two mechanisms may work as substitutes for each other. Finally, when the joint endogeneity and unobserved firm heterogeneity are accounted for, no systematic relationship is being found between the CEO incentive pay and firm value, suggesting the CEO's incentive scheme is chosen endogenously, a result consistent with Palia (2001).