Incentive compensation in energy firms: does regulation matter?

Manuscript Type: Empirical Research Question/Issue: While regulation reduces the discretion of CEOs, it is also expected to prompt effort and efficiency. This paper develops a link between regulation and the two main competing theories of executive compensation (efficiency vs. entrenchment) and investigates whether CEO pay-performance sensitivity differs across alternative regulatory regimes in the European energy industry. Research Findings/Insights: Using a panel of energy utilities from 12 EU countries tracked from2000 to 2011,we find that managerial compensation is sensitive to performance only if the firm is subject to incentive regulation, not in the case of cost-based contracts. We also find that incentive regulation makes managerial entrenchment less likely, while CEOs subject to cost-based regulation appear to be more entrenched with the board, obtaining compensation that may even increase when (accounting) performance deteriorates. Theoretical/Academic Implications: We derive a conceptual framework that enables us to investigate the interplay between the strength of corporate governance (incentives vs. board monitoring) and the type of regulatory contracts. Practitioner/Policy Implications: Our findings suggest that in industries where competition looms – mimicked by the regulatory framework – CEO compensations are more responsive to stock-based and accounting performance measures and managerial entrenchment is less likely. Hence, corporate governance (monitoring and/or compensation) and regulation complement each other. In contrast, where regulation is not efficiency oriented, the adoption of performance-related contracts seems to bring no advantage to firms and only additional costs to shareholders, also due to CEO entrenchment.