Objective of Research: In this paper Jensen & Murphy set out to prove the positive relationship between performance incentives and firm performance and sub sequentially, the decline in correlation between the two variables.
Methodology: Jensen & Murphy used the Executive Compensation Surveys published in Forbes. This data was then matched with firm data on Compustat and the Center for Research in Security Prices. Using this compilation of data the authors study the effects of varying manager incentives (cash, stock options, inside stock ownership, threat of dismissal).
Main Findings: The relationship between managers wealth, when anchored with performance incentives, and shareholders wealth has a positive relationship but is decreasing in strength. They conclude that this is partially due to the public nature of manager compensation and the scrutiny of high compensation. As noted in the paper, “Truncating the upper tail of the the payoff distribution requires that the lower tail of the distribution also be truncated...”
My Assessment: I believe that Jensen & Murphy achieve what they set out to do with this paper. Throughout the paper they show that their is a positive relationship between CEO wealth changes and shareholder wealth changes. Based on the data they had available at the time, and through the academic lens of which they viewed this issue i think they did the best they could. I do however disagree with the conclusions reached in the paper. I base my disagreement on recent research done by various behavioral economists but most notably Professor Dan Ariely of Duke University. In his book “The Upside of Irrationality” Ariely examines the relationship between incentives and performance. Contrary to what Jensen & Murphy conclude, Ariely shows through behavioral studies that incentives and performance can have a negative relationship.
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