Directors' Pay, Growth and Profitability

THE last i5 years have witnessed a series of theoretical works that have sought to replace the traditional motive of company directors, maximization of profit, with the maximization of some form of growth.' In support of this new maximand, several writers maintain that increases in size present overwhelmingly greater material incentives to directors than do increases in profitability. Several analysts have reviewed the evidence for this contention, using correlation or regression techniques to estimate the respective influence of size and profitability on pay. Studies before I970 obtained results that were surprisingly decisive by the standards of applied economics, and reported in favour of the 'managerial theorists arguments with remarkable unanimity.2 The relation between size and pay was found to be positive and passed the usual statistical significance tests with flying colours, whereas that between profitability and pay earned only scorn: the estimated coefficient was not significantly different from zero even at the permissive 5% level. In 1970 the harmony was disturbed by Lewellen and Huntsman [i], who declared, on the basis of new estimates, that '. . . reported profits are substantially more important in the determination of executive compensation than are sales-indeed sales seem to be quite irrelevant.. .'3 This paper, using hitherto unavailable data for a very large sample of U.K. companies,4 reconciles these apparently conflicting statistical results; and, in interpreting them, rejects both extreme positions.