You get what you Pay for: The Effect of Top Executives’ Compensation on Advertising and R&D Spending Decisions and Stock Market Return

Abstract

Although there is literature on how top executives’ compensation influences general management decisions, relatively little is known about whether and how compensation influences advertising and research-and-development (R&D) spending decisions. This study addresses two questions. First, is there an incentive effect of long- versus short-term compensation on advertising and R&D spending? Second, is there a mediation effect of advertising and R&D spending on the relationship between long- versus short-term compensation and stock market return? The authors address these questions using a combination of ExecuComp, Compustat, and Center for Research in Security Prices data on 842 firms during the 1993–2005 period. They find that an increase in the equity to bonus compensation ratio is positively associated with an increase in advertising and R&D spending as a share of sales. Advertising and R&D spending as a share of sales also mediates the effect of equity to bonus ratio on stock market return. The authors discuss implications for top management seeking to mitigate myopic management of resources by employing compensation to incentivize a longer-term orientation for advertising and R&D spending to improve stock return.