The effect of cultural distance on contracting decisions: The case of executive compensation

This paper focuses on how differences in national culture may relate to cross-country differences in the structure of executive compensation contracts. We know that firms design executive compensation contracts to reduce conflicts of interest between owners and managers. We contend that cultural context affects these conflicts of interest and hypothesize that firms from cultures that are similar (different) should design compensation contracts that are similar (different). To specify cultural context, we calculate cultural distance using value dimensions from Hofstede (1980) and test for a relation between culture and contracting using compensation data for 39 countries from 1996-2009. Our findings indicate that culture is a significant determinant of cross-sectional differences in compensation structures. These results are robust to our use of instrumental variables methodologies (to mitigate concerns of potential omitted variables and reverse causation). By exploring the relatively unexplored impact of national culture on compensation structure, we hope to contribute to a better overall understanding of contracting decisions.