The Relationship Between Executive Compensation and Firm Performance in Kenyan Banking Industry

THE RELATIONSHIP BETWEEN EXECUTIVE

COMPENSATION AND FIRM PERFORMANCE IN

KENYAN BANKING INDUSTRY

Dr. Josiah Aduda, [e-mail], Lecturer and chairman, department of Finance and Accounting, School of Business, University of Nairobi, Kenya and Leonard Musyoka, University of Nairobi

Abstract
Economic theory of executive pay has focused on the design of optimal compensation schemes to align the interests of hired managers and shareholders. Agency theory has identified several factors by which these interests may differ; including the level of effort exerted by the manager and problems resulting from the unobservabilty of the agent’s relevant skills. The design of optimal compensation contracts essentially trades-off between different incentive problems and risk-sharing considerations. Research has also been directed to the identification of proper performance standards for evaluation and compensation.

The study sought to examine the relationship between executive compensation and firm performance. The study considered functional form relationship between the level of executive remuneration and accounting performance measures by using a regression model that related pay and performance. The findings of the study suggest that accounting measures of performance are not key considerations in determining executive compensation among the large commercial banks in Kenya and that size is a key criteria in determining executive compensation as it was significantly but negatively related to compensation. The negative correlation suggests the capping of executive compensation to ensure maximization of returns to shareholders.

Keywords: Executive Compensation, Firm performance, Agency theory

1. Introduction

1. Background of the Study

The relative importance of various factors used to measure the performance of agents should be related to how well each measure informs the principal about the agent’s actual performance (Banker and

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