CEO compensation and firm performance : Evidence from the US property and liability insurance industry

Purpose – The purpose of this paper is to examine the relation between chief executive officer (CEO) compensation and firm performance proxied by efficiency estimated from data envelopment analysis (DEA) of the US property‐liability (P&L) insurance industry. Design/methodology/approach – This study was conducted in two stages. First the authors applied DEA model to calculate efficiency scores. In the second stage, a translog model was used to correlate the level and structure of CEO compensation and the efficiency for the sample P&L insurers over the period of 2000‐2006. Findings – Firm efficiency is positively and significantly associated with total CEO compensation. While revenue efficiency is associated with CEO cash compensation, cost efficiency is associated with incentive compensation. Practical implications – These findings suggest that while CEO compensation is tied to both revenue and cost efficiency, revenue efficiency is more important in determining cash compensation, and cost efficiency is more prevalent in influencing incentive compensation. Originality/value – This is the first paper to use efficiency scores as proxies for firm performance to explore the relation between CEO compensation and firm performance in the P&L insurance industry. Due to the nature of insurance business, using efficiency as a performance measurement is more appropriate than accounting and financial ratios since it enables us to net out the effects of differences in exogenous firm‐specific conditions that are beyond management's control.