This study examines the relationship between executive compensation of chief executive officers (CEOs) and firm performance in the insurance industry using a four-year sample from 1997 to 2000. In the first essay, the study makes use of single equation models to examine the effect of firm performance on executive compensation. The Huber/White sandwich estimators are used to correct for heteroscedasticity in the data. The results show that a positive change in executive compensation is associated with a positive change in firm performance. Both the sensitivity and elasticity specifications of the pay-performance relationship are estimated for comparison. The results show that the elasticity estimation is more robust to firm size as compared to the sensitivity estimation. The findings are consistent with prior research. The study also investigates the difference in pay-performance relationship between life/health insurance companies and property/casualty insurance companies. There is some evidence that for small insurers in the sample, for the same change in firm performance, life/health CEOs receive smaller adjustment in compensation than property/liability CEOs. The difference gets smaller as the size of the insurance companies get larger. The next part of the analysis takes into account that firm performance and executive compensation are likely to be jointly determined. A simultaneous equation model is used in order to allow for the possible joint determination of pay and performance. Three-stage least squares method is used for the estimation. The findings support the hypothesis that there is a two-way relationship between executive pay and firm performance. An increase in CEO compensation leads to higher firm performance and an improvement in corporate performance leads to an increase in CEO compensation. The second essay is an excerpt of the latter part of the analysis in the first essay.
