An effective performance-based compensation system must increase the probability of
high performance corporate outcomes in order to justify the incremental expense relative
to a straight salary system. A positive relation between current performance and current
compensation indicates that the pay system is performance-based in practice, if not
explicitly. This study considers whether increasing the sensitivity of current
compensation to current performance is associated with higher performance in the future.
For accounting-based performance measures, there is only weak evidence that greater
performance-based compensation is associated with improved future performance. However,
for economic and market performance measures, there is stronger evidence. Payment of an
incremental 10% bonus for good economic performance is associated with a 30 to 90 basis
point increase in the expected after tax gross economic return in the following fiscal
year. Payment of an incremental raise of 10' following a good stock market performance is associated with a 400 to 1200 basis point increase in expected total shareholder return.
These results are comparable in magnitude when compared to the intrinsic variability of
the performance measure considered.
*Published:
ILRR, Vol. 43, no. 3 (1990): 52S-73S.
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