2025

Hundal, Shabnamjit; Borén, Christina; Eskola, Anne

The executive directors of firms are expected to serve in the best interests of the firms that they are affiliated with. However, agency costs can start appearing when the chief executive officer (CEO) and other top executives put their personal interests before those of the firm. Theoretically, the firm performance-based compensation is reckoned as an important bonding measure that can align utility functions of both principal and agent to minimize the agency costs, however, no clear consensus is found in the empirical research regarding the effectiveness of this measure. The current study explores, first, whether corporate boards of directors’ characteristics impact the relative share of performance-based pay in the total compensation of CEOs, and second, whether the performance based compensation of CEOs affects the firm performance. Based on the analysis of secondary data of 113 large-cap Nordic publicly traded manufacturing firms for the period from 2012 to 2022, the findings show that performance-based pay of CEOs has a positive impact on the financial performance of the sample firms. The results also demonstrate that board size and performance based pay of CEOs are negatively associated as it is expected that there is a relative ease in forming optimal compensation contracts of CEOs in smaller boards. However, this finding is opposite to several other studies that identify a positive association between the board size and performance-based pay of CEOs as bigger boards are more resourceful in making optimal decisions including CEOs’ compensation contracts. Furthermore, board independence affects the performance-based pay of CEOs favourably. Similarly, the proportion of debt in the total financing of firms unfavourably affects both accounting and stock market performance measures.