CEO Compensation In Poorly Performing Firms

This paper studies the association between CEO compensation and firm performance in solvent but poorly performing firms. By focusing on solvent firms, this study insulates the bankruptcy effects (and the complex creditor-shareholder-manager effects) on pay-performance relationship. Furthermore, there is a widespread belief that CEO pay in such firms does not reflect firms’ poor performance. I find that on average, the level of CEOs cash compensation is positively related to the firms’ level of operating cash flows. I interpret this finding as suggesting that stockholders of poorly performing firms reward CEOs in the short-run, for the effect of the managerial decisions on cash flows. However, change in CEOs compensation is unrelated to any measure of the changes in firms’ performance. This is consistent with the cautious approach of stockholders to wait and see, if change in performance is more permanent