Stock-based compensation and performance – does compensation that leans more toward executives create better ROE performance?

Rotman School of Management, University of Toronto, Toronto, Canada

^* Corresponding author: xinming.jiang@mail.utoronto.ca

Abstract

While executives are often seen as the centre of corporate governance, making important decisions, impacting firm operations, they are often compensated generously by stock-based compensation. The cost of compensating them is significant and material. At the same time, whether such high compensation is worthwhile is questionable, especially when the compensation is unequally high compared to that of ordinary employees. This study examines the impact of stock-based compensation disparity between executives and average employees on firm performance. Utilizing data from publicly traded North American firms between 2015 and 2019 from Compustat’s Fundamental Annual and Execucomp, this paper applies statistical methodologies to analyze the causality between compensation structure and Return on Equity (ROE). This paper provides insights into the effectiveness of compensation strategies by developing a model that projects firm performance based on the CEO-to-employee stock-based compensation ratio. The findings indicate a statistically significant relationship between compensation disparity and firm performance, with a positive correlation suggesting that higher CEO compensation relative to employees may contribute to improved ROE. Along with the model, this study highlights the importance of understanding compensation structures in optimizing firm outcomes.