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

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THE RELATIONSHIP BETWEEN EXECUTIVE

COMPENSATION AND FIRM PERFORMANCE IN

KENYAN BANKING INDUSTRY

Dr. Josiah Aduda, jaduda@uonbi.ac.ke, 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
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For decades accounting measures have been used as primary indicators of managerial performance with prior research documenting a significant relation between accounting based performance and executive compensation (Antle and Smith, 1986, Ittner, et al., 1997). Moreover, both the annual cash bonus and the sum of the cash bonus plus stock based compensation have been linked to accounting based performance as well as numerous other attributes of the firm’s governance structure (Core, et al., 1999).

The compensation aspect suggests that most annual cash bonus plans for key executive officers are based in large part on accounting performance measures (Ittner, et al., 1997). There is also some relation between accounting performance and stock based compensation in many firms since the pool of stock options or stock awards to be distributed each year is often based on annual accounting performance measures. There is a high degree of correlation in the total annual inceptive pay amongst the top executives in each firm, and it is commonly assumed that what is observed for the CEO is representative of the incentive pay for the entire top management team for most entities (Antle & Smith, 1986; Gore, et al., 2003; Ittner, et al., 1997). Accounting and finance has also extensively been debated on as to whether accounting information should be used to measure managerial performance (Bushman and Indjejikian, 1993; Kim and Suh, 1993;
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