Critically Review the Literature on the impact of managerial compensation on firm performance


In this report, researcher discusses the subject area of corporate governance while discussing on the managerial compensation on firm performance. This study is based on critical analysis of the research topic in which researcher has discussed the research study on the basis of the past findings related to the research topic.

Furthermore, this study supports to introduce various theories related to corporate governance and has supported to understand the differences in corporate control patterns across the world in the context of managerial compensation on firm performance.

The lecture shows that corporate control and ownership in the UK and USA differ markedly from corporate control and ownership in the rest of the world.


Jenter, & Kanaan (2015) depicted that corporate governance is the system which is based on rules, regulations, practices and processes. It enables the organization to direct and control.

Corporate governance supports to balance the interests of the different stakeholders of the company, such as management, employees, shareholders, customers, suppliers, financiers, government, community, etc. According to the views of Ju, Leland, & Senbet (2014), the UK and US corporate governance approach is principles-based and both the countries are focused towards following the proper regulations.

In like manner, the UK approach uses codes of best practice such as comply or explain approach. However, US corporate governance approach is much more in line as it is designed while considering the civil law. US approach utilizes the Sarbanes–Oxley Act, Dodd–Frank Act, etc.

Hambrick, & Quigley (2014) depicted that there are different nature of control in the context of governance. In the context of Europe, industrial and holding firms are the major shareholders.

However, in the UK and Netherlands, institutional shareholders are the major shareholders. In like manner, in Continental Europe, Family control plays vital role. However, in the UK, control by the management is important. Moreover, in US corporate governance controlling approach remains concerned towards the civil law.

In the context of US, organizations give huge concern towards managerial compensation which enables the corporate to increase the company growth by fulfilling the given task on time with accuracy, quality, innovation and creativity. Firm performance play crucial role towards the organization.

Due to this reason, corporate utilizes various strategies which enable the firm to improve the employee performance. Corporate utilizes various measurements to judge the performance of the managers and to judge the influential factors which enable towards improving the managerial performance.

According to the theories of Li, et al. (2014), manager plays the role of leader and if the manager is motivated then the firm becomes able to show effective organizational performance. From the survey, it is identified that motivated leader leads the team in a better manner (Crossland, et al., 2014).

However, in the contrary, Quigley, & Hambrick (2015) argued that there is a strong relationship between managerial compensation and organizational performance however, there are many other factors which also plays vital role in improving the managerial performance such as motivation, recognition, self-actualization, etc.

At the same time, it is identified that annual cash bonus based compensation is linked towards the corporate accounting based performance and many other attributes related to the corporate governance structure (Huang, et al., 2017).

For this purpose, economic theory is used by the researcher to judge the importance of economic compensation towards the corporate performance. This theory will remain highly assistive to give a deep understanding regarding the importance of managerial compensation.

In this research paper, researcher will discuss various theories related to managerial compensation and its impact towards firm performance. It will support towards giving the detailed understanding regarding the research topic.

This study will support to give answer regarding why it is essential to give compensation to the managers? What is the impact of managerial compensation towards the organizational performance? Why management gives consideration towards managerial compensation while designing the policies for corporate governance? This study will support to identify the measures of managerial compensation.

Accounting measures can be taken as primary indicators of managerial performance while giving concern towards prior research documentation regarding the significant relationship between accounting based performance and according to that managerial compensation takes place (Zhu, & Westphal, 2014).

This paper will support towards giving deep understanding regarding the research topic by critically review the literature to get the understanding regarding the impact of managerial compensation on firm performance.

For this purpose, researcher has given focus towards evaluating the research topic on the basis of various theories which has supported to offer detailed understanding regarding the research topic.

This study is based on secondary data analysis and has supported to understand the views of various researchers and their findings to conclude the study in an effective manner.

It is identified that financial institutions require separate set of corporate governance as well as risk management regulations. In this context, managerial compensation plays crucial role. Barrick, et al. (2015) depicted that the rise in global capitalism such as financialization, neoliberalism and privatization have increased the concern towards corporate governance.

There are various laws and finance literature is designed while focusing towards the hierarchy of corporate governance systems which has supported towards understanding the concept of the complementarities.

Economic Theory

According to economic theory, managerial compensation supports towards increasing the interest of the managers for the accomplishment of the given task (CHENG, Hong, & Scheinkman, 2015). It supports towards aligning the interest of the employees through the managers.

While designing the corporate governance, organization gives focus towards designing the optimal compensation schemes for executive pay to align the interests of the managers as well as the shareholders as they play crucial role towards improving the organizational performance.

Hsu, Chen, & Cheng (2013) stated that managers play the role of driving force as well as catalyst. So, it is essential to focus towards the strategies which can boost the managers. In this context, it is identified that monetary rewards play vital role. Due to which while designing the corporate governance organization gives huge focus towards managerial compensation.

Agency Theory

Agency theory supports to understand the relationship between principals and agents in the corporate. Agency relationship takes place in finance between the shareholders and the company executives. Peng, Sun, & Markóczy (2015) stated that according to agency theory, it is identified that there are several factors which supports to analyze that there are various parameters through which the interests of the managers can be analyzed.

Corporate governance gives concern towards designing the optimal compensation contracts with the managers which are offered to the managers through different incentives while giving concern towards risk-sharing.

According to the views of Gamache, et al. (2015), compensation supports to ensure maximization of returns to the shareholders which enables towards identifying the effective relationship between executives and shareholders.

Moreover, Zattoni, Gnan, & Huse (2015) opined that the negative correlation with the managers decreases the observation of the agent’s relevant skills which decreases the organization performance and creates negative working environment. Moreover, it creates problems between the management and the organization. Barrick, et al. (2015) depicted that the conflict in the interests which appears between the owners and managers is known as agency problem.

In most of the cases, the owners want that the managers take appropriate actions on behalf of the organization while giving concern towards organizational interests which supports towards maximizing the wealth of shareholders.

Contract Theory

Agency problem is accompanied with the development of contract theory. According to this theory, the firm is considered as a set of contracts among various factors which are related to production. In like manner, every single factor acts completely towards motivating the employees while maximizing the self-interest.

Under this theory, the organizational team is lead by one or more persons to accomplish the organizational task on the behalf of the organizations which supports to delegate the decision making authority in an effective manner with the help of the agents (Boehm, et al., 2015).

Both the parties act towards maximizing their own utilities while giving concern towards divergences which occur between the interests of the organization with the actions of the agent.

Entity Theory

According to entity theory, the company is an entity as a whole which separates the responsibilities between the owner and the management of the organization (Ferri, & Maber, 2013).

The owner appoints the managers while giving consideration towards reliability and trust. Moreover, owner gives consideration towards the controlling power of the company. However, when there is any problem arises between the relationship of owners and management, then it creates the issue towards the organization performance.

Due to this reason, owners pay the effective compensation to the management so that they act in accordance with the interests of the shareholders. Moreover, shareholders do not hesitate to give good compensation to the managers if the firm becomes able to increase the profit margin.

In this context, Hambrick, & Quigley (2014) depicted that the better the organizational performance, the greater the managerial compensation received by the managers. This compensation supports to motivate the managers to lead the team in an effective manner which supports towards improving the overall firm performance.

At the same time, _ determined that improved firm performance supports towards increasing the company profitability which enables towards increasing the firm value. Due to which, shareholders wealth will also increases. So, it is necessary to boost up the skills of the managers for improving the managers and to linking them with the organizational performance.

Social network theory

Social network theory suggests that board members of the organization remains focused towards developing and solidifying the friendship or social ties with the management. It supports towards increasing the tenure of the employees while giving concern towards employee satisfaction.

According to the views of Quigley, & Hambrick (2015), corporate governance institution, it is believed that for creating longer relationship with the managers, it is essential for the owners to motivate the employees.

In this context, Huang, et al. (2017) stated that monitory rewards play vital role towards encouraging the employees to perform better service. Increasing the concern towards the managerial compensation, enables the firm to increase the organizational performance as managers are the leading executive of the firm and they monitor the employee performance while giving concern towards various performance.

In like manner, Barrick, et al. (2015) stated that managers play vital role towards decision making while focusing towards innovation and creation which enables towards increasing the customer interest. Moreover, managers give concern towards the utilization of effective process and procedures which enables the firm to decrease the company cost while increasing the productivity.

It supports towards making the managers active towards the achievement of organizational goal. Additionally, it supports the owners to increase the tenure limits of the employees. Due to this reason, US firms give high concern towards managerial compensation while designing corporate governance.

It supports the firm towards increasing the innovation in the product range of the firm. Ferri, & Maber (2013) stated that types of shareholders differ between the UK and USA as well as the rest of the world. So, while designing the corporate governance it is essential to understand the industry need of a particular country.


Corporate Governance Life cycle

From the above graph, it can be understood that at the birth and growth stage firm has negative cash flow. At the same time, the financing method is equity and the dividend payout is also less. However, in the contrary, in the maturity and decline stage firm’s financing method will debt and dividend payout is also high.

Although the cash flow in maturity stage is positive however, in decline stage, it is neutral. From the above graph, it can be understood that in different stage firm has to utilize different strategy according to the requirement of the circumstances.

In support of this, Hambrick, & Quigley (2014) depicted that human resource is the major resource of the organization and no firm can run without it. So, it is essential to give concern on the human resource at every stage.


From the above study, it can be discussed that managerial compensation impacts the organizational performance. So, to improve the organizational performance, owners need to increase their concern towards this perspective. In this context, various theories have supported to giving deep understanding. In the current scenario, due to increase in the competition, organizations need to focus towards various parameters for the purpose of improving the organizational performance.

However, in the contrary, Crossland, et al. (2014) argued that there are various other factors too which owners need to focus to improve the organizational performance. It is true that managerial compensation play vital role to improve the organizational performance. However, there are many other parameters too which should be focused.

Company needs to increase the concern towards hiring the managers who are skilled and have a capability of utilizing the leadership style according to the situational requirement (Barrick, et al., 2015). In like manner, organizations should focus towards increasing the concern towards safety measurement, employee satisfaction, positive working environment, proper training and development, etc.

All these parameters support the firm to increase the efficiency of the employees and will support towards organizational upliftment. Additionally, utilization of latest and advanced technology remains assistive towards improving the productivity and to deliver the products in the market and to the client on a timely basis.

However, managerial compensation also plays important role within the organization. According to social network theory, managerial compensation enables the firm to make effective relationship between the owner and the manager.

Manager plays the role of bridge between employees and owner and effective communication of manager can run the organization in the right direction. Additionally, it is identified that it supports towards creating competitive advantage and long-term sustainability in the industry (Hsu, Chen, & Cheng, 2013).

Due to this reason, the organizations of US give high consideration towards this perspective while designing the managerial compensation. However, contract theory has supported to understand that organizations of US are use proper documentation for the managerial compensation as a deal.

According to which managers get compensation on the behalf of the improved performance. On the other hand, as per the entity theory, organization delegates the responsibilities to the management. Organization offers the compensation to the employees to give them the feeling of the entity of the organization so that they become able to perform better towards the organization welfare.

Healthy relationship between the management and organization supports towards improving the organizational performance (Ju, Leland, & Senbet, 2014). Due to this reason, organization is highly focused towards this concern. Moreover, agency theory has supported to understand the relationship between the shareholders and the company executives.

It has supported to understand that employees get hugely motivated through financial reward. Compensation enables the employees to perform better and to lead the team in an adequate manner. Incentives enable the firm to increase the manager concern towards eliminating the risk parameters (Zattoni, Gnan, & Huse, 2015).

Additionally, agency theory has supported to analyze that managerial compensation supports towards making effective relationship between the owners and the company agents. Agency relationship supports to make effective relationship between the shareholders and the company executives in the context of finance.

All these theories have supported to understand the importance of managerial compensation in the context of organizational performance while giving deep understanding regarding its essentiality to concern during designing the corporate governance (Eccles, Ioannou, & Serafeim, 2014).

It is identified that giving concern towards the managerial compensation enables the firm towards the reduction of the agency problems while decreasing the risk factor. It supports towards limiting the managerial entrenchment.

In like manner, it enables to increase the concern shareholders interests which supports to maximize the investment from the side of the investors as well as to increase the company sells. It supports towards increasing the brand loyalty which enable towards increasing the profitability of the firm (Cuñat, Gine, & Guadalupe, 2016). It enables the firm towards increasing the positive working environment while increasing the sustainability.

It enables the firm to create long-term sustainability in the industry while making effective relationship with the managers. Long-term working in an organization enables the organization towards value enhancement.

On the other hand, according to the views of Zhu, & Westphal (2014) managerial compensation increases the company cost. However, Quigley, & Hambrick (2015) identified that this increased cost supports the firm to improve the organizational performance. Additionally, according to the views of Ferri, & Maber (2013), it is identified that alone compensation cannot increase the organizational performance.

So, there is a need of increasing the concern towards the other parameters too. In this context, training program plays effective role as it enables the firm to brush up the skills as well as to develop the new skills within the employees. At the same time, giving concern towards safety measurement and positive working environment is also necessary.

Additionally, increasing the employee satisfaction is also necessary while focusing towards self-actualization, motivation, encouragement, recognition, etc. parameter.

Conclusion & Recommendation

From the above study, it can be concluded that it is essential to give concern towards managerial compensation as it enables towards firm growth.

Due to this reason, US firms are highly focused towards this parameter which has supported them to perform well in the current competitive environment. It is essential for the firm to increase the concern towards the managers as they are driving force of the organization and supports to lead the firm in the right direction.

In like manner, managers work like a catalyst towards improving the organizational performance. Additionally, there is a need of increasing the concern towards motivating the managers while giving concern towards other parameters too.


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