Executive pay research has traditionally focused on salary, severance payments and longtermincentives. A systematic rigorous empirical examination of short-term annualbonuses is lacking. To address this omission, this research empirically examines therelationship between short-term bonuses and firm performance (TSR and EPS), in theUK. It also considers the association between form of bonus payment (i.e. cash/shares),and type of performance target (i.e. hard/soft and simple/complex) with bonus andperformance. Furthermore, firm size and particular corporate governance factors areincluded (i.e. NED ratio on remuneration committee, CEO presence on nominationscommittee, CEO/Chair duality, tenure, and power) to examine their relationship withbonus value.From a sample of 299 firms listed in the FTSE-350 (1,542 executives including 300CEOs), this study uses two competing theories (i.e. agency and power theory) to providea fuller explanation of the subtleties of the pay-performance relation. The main findingssupport the agency view, since bonus is positively and significantly associated withfinancial performance. As with previous studies on executive bonus pay this associationremains weak. By implication, power theory is not supported.However, other findings indicate: (1) although firm size may change, the proportion ofbonus pay relative to salary does not vary. This suggests that large and small firms payout proportionally similar bonuses; (2) cash bonuses are not positively related with thetotal value of bonus pay, suggesting that they are not any more open to abuse than othermethods of compensation, as agency theory would predict; (3) cash bonuses encourageshort-term achievement, as predicted by power theory; (4) consistent with agency theory,share-based bonuses are positively related to bonus pay and performance (weakassociation), suggesting that share-based bonuses (rather than cash bonuses) may bemore effective at aligning pay with performance; (5) in line with agency theory,transparency (i.e. hard (external/published) and simple bonus conditions) is positivelyassociated with performance, providing support for the alignment between principals’and agents’ interests; (6) detailed bonus scheme characteristics are generally insensitiveto performance and are becoming increasingly softer (i.e. more internal/unspecifiedtargets) and complex (i.e. multiple targets). On the power view, these may createopportunities for executives to mask weak performance and extract greater rents; (7)governance factors are insignificant, suggesting that efforts to improve this area may bewasted, since they mainly leave pay-performance sensitivities unaffected. However,based on power theory, weak governance may foster the rise of powerful executives andwiden the pay-performance gap. Therefore, it is suggested that close monitoring ofexecutive pay must continue and shareholders should remain vigilant.
