The management of executive compensation in large, dynamic firms: A further look

Abstract

It has long been recognized that management is rewarded on the basis of achieving its goals. Thus, executive compensation is typically modeled in terms of sales, a proxy for firm growth, and profits, a proxy for firm financial performance. Histori-cally, economists have intensely debated whether executives are rewarded for maximizing profits (the classical hypothesis) or sales (the more recent corporate growth hypothesis). Empiri-cal support, using ordinary least squares (OLS) regression, has been offered for both positions with more recent studies suggesting that both positions may have merit. Unfortunately, the extreme multicollinearity that typically exists between profits and sales may render studies utilizing OLS regression inappropriate for resolving the debate. It is the purpose of this paper to contrast the results of OLS with two biased regression procedures (ridge regression and latent root regres-sion) in modeling the determinants of executive compensation.

Keywords:

• multicollinearity
• latent root regression