The impact of CEO compensation and CEO horizon on a firm\u27s discretionary research and development expenditures

Agency costs are said to arise as a result of the separation of ownership from control inherent in the corporate form of ownership. One such agency problem concerns the potential variance between the time horizons of principal shareholders and agent managers. Agency theory suggests that these costs can be alleviated or controlled through performance-based Chief Executive Officer (CEO) contracting. However, components of a CEO\u27s compensation contract can exacerbate or mitigate agency-related problems (Antle and Smith, 1985). According to the horizon hypothesis, a self-serving CEO reduces discretionary research and development (R&D) expenditures to increase earnings and earnings-based bonus compensation. Agency theorists contend that a CEO\u27s market-based compensation component can mitigate horizon problems. This study seeks to determine whether there is a relationship between CEO earnings- and market-based compensation components and R&D expenditures in the largest United States industrial firms from 1987 to 1993. Consistent with the horizon hypothesis, results provide evidence of a negative and statistically significant relationship between CEO cash compensation (i.e., salary and bonus) and the firm\u27s R&D expenditures. Consistent with the expectations of agency theory, results provide evidence of a positive and statistically significant relationship between market-based CEO compensation and R&D. Further results of this study provide evidence of a positive and statistically significant relationship between CEO tenure and the firm\u27s R&D expenditures. Although there is a negative relationship between CEO age and the firm\u27s R&D, it was not statistically significant at the 0.5 level