The effect of equity-based compensation on firm performance

Abstract

This study investigates the effect of equity-based compensation for CEOs and management on firm performance in the Swedish market. Based on agency theory, we test the hypothesis that equity-based compensation aligns the interests of management and shareholders to improve firm performance. The study uses a quantitative approach with a sample of firms listed on NASDAQ-OMX Nordic during the period 2019-2024, resulting in an unbalanced panel dataset consisting of 585 observations from 149 unique firms. To address the potential problem of reverse causality, lagged independent variables are utilized in an Ordinary Least Squares (OLS) regression with firm and year fixed effects. Firm performance is measured using Tobin’s Q and Return on Assets (ROA). The results reveal no statistically significant linear relationship between equity-based compensation and firm performance for either CEOs or management. However, a non-linear analysis reveals that the effect of CEO equity-based compensation differs across compensation levels. For accounting-based performance, low levels of equity-based compensation show a positive and significant effect on ROA, while this effect disappears at higher levels. For market-based performance, the pattern is the opposite, with higher levels of CEO equity, based compensation showing a positive effect on Tobin’s Q. The study concludes that no positive linear relationship can be established for Swedish listed firms during the observed period, but that the effect is non-linear and that specific levels improve firm performance.