Do Economic Profit Companies Walk Their Compensation Talk?

Abstract

This article reports the results of an analysis of a matched sample of companies that use economic profit (EP) as part of their criteria for awarding incentive compensation for their Named Executive Officers (NEO) compared with competitor firms that do not (non-EP firms). Companies using EP display stronger relationships between changes in estimated EP and changes in yearly NEO average total compensation. A number of other financial metrics are compared between the two samples. Interestingly, the within sample, cross-firm analyses show weaker relationships between compensation and estimated EP for EP firms than for non-EP firms. This weaker relationship may be due to an unobservable, underlying factor stimulating a company’s adoption of EP as a criterion for the incentive compensation part of yearly NEO average total compensation.