The impact of firm size on pay-performance sensitivities

Previous work by Aggarwal and Samwick [Aggarwal, R., Samwick, A., 1999. The other side of the tradeoff: the impact of risk on executive compensation. Journal of Political Economy 107 pp. 65-105] has documented the importance of controlling for the variance of firm stock returns when estimating pay-performance sensitivities. They find that pay-performance sensitivities are an order of magnitude greater for small vs. large variance firms. Using a comparable sample of CEOs, I provide evidence that when properly controlling for firm size, the negative effect of variance in stock returns on estimated pay-performance sensitivities is greatly diminished. In particular, when using dollar returns as the measure of firm performance, it is imperative to properly control for firm size.