Bank performance and executive pay: tournament or teamwork

Peiyi Yu () and Bac Luu
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Peiyi Yu: University of East London
Bac Luu: Norges Bank Investment Management

Review of Quantitative Finance and Accounting, 2016, vol. 47, issue 3, No 7, 607-643

Abstract: Abstract We investigate the relationship between the dispersion of executive pay and bank performance/valuation by examining two competing theories, the tournament theory (hierarchical wage structure) and the equity fairness theory (compressed wage structure). The key variable of executive pay dispersion is measured using a hand-collected dataset composed of 63 banks from OECD countries and 29 banks from developing countries. The dataset covers the period 2004–2012. By combining and modifying a translog profit function and a pay-dispersion model, we are able to address the potential problems of relying on reduced-form estimation. In our subsample of developed and civil law countries, where bank performance is measured by either Tobin’s Q or by the price-to-book ratio, the overall impact of executive pay dispersion is mostly negative, and we find supporting evidence for the equity fairness theory, except for very high levels of dispersion. There is a non-linear effect, as banks perform best when there is either very low or very high executive pay dispersion. For developing country sample banks, greater executive pay dispersion has a negative impact on bank profit. In our subsample of common law countries, however, we find no evidence of a significant impact of executive pay dispersion on bank performance. We conclude that lower executive pay dispersion, a proxy for teamwork, is mostly effective in enhancing bank performance in a significant section of sample banks, i.e., civil law and developing countries.

Keywords: Equity fairness theory; Tournament theory; Pay dispersion; Executive compensation; Banking; Translog profit function (search for similar items in EconPapers)
JEL-codes: G20 G21 G28 G34 J33 M52 (search for similar items in EconPapers)
Date: 2016
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Citations: View citations in EconPapers (4)

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DOI: 10.1007/s11156-015-0514-4

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