The relationship between executive compensation and firm performance in the Kenyan banking sector

Abstract

Economic theory of executive pay has focused on the design of optimal compensation schemes to align the interests of 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. This study examined the relationship between executive compensation and firm performance among the commercial banks listed at the Nairobi Stock Exchange. The study considered functional form relationship between the level of executive remuneration and accounting performance measures by using a regression model that relates 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.