Organizational form, executive compensation, and the performance of the firm: The case of life insurance industry
The separation of ownership from control may lead to incentive problem(s). Adam Smith (1776) argued that these incentive problems arise when the decision making in a firm is the province of managers who are not the firm's security holders. One outcome has been development of agency theory which examines the principal - agent relationship binded by a contract. The contract gives authority to the agent to make decisions on behalf of the principal and also determines the agent's compensation. This study addresses the relationship between pay and performance in the life insurance industry. A set of hypotheses relating the pay - performance relationship are derived from the extant theory. The major part of the dissertation aims to test these hypotheses. The first stage tests are designed to estimate the sensitivity of the relationship. Second stage tests are performed to explain cross firm differences in the pay - performance relationship. Among the explanatory variables are organizational form, leverage, expense ratio, distribution system and size of the firm. The first stage results do not support for a relationship between direct cash payment (salary, bonus, salary plus bonus) and our measures of firm performance. But the cross-sectional differences of the pay - performance relationship are generally explained by different characteristics of the insurance firm. However, the general pattern is confusing. The question is do we have problem(s) with the accounting measures? On the assumption that accounting values provided similar information in non-traded firms, a synthetic measure of market return on equity was estimated for the non-traded firms. This synthetic measure results generally support the negative expected sign of expense ratio. It also supports the positive expected sign of the ownership structure variable. This robust result seems to suggest that the stock firms are able to compensate their managers in a way that gives them an incentive to work hard and achieve better performance.
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