The Impact of Executive Compensation and R&D Expenses on Firm Performance: A Comparison between Manufacturing and Services Companies in the United States Nikolas Karakatsanis |ERASMUS SCHOOL OF ECONOMICS The Impact of Executive Compensation and R&D Expenses on Firm Performance: A Comparison between Manufacturing and Services Companies in the United States Master Thesis The Impact of Executive Compensation and R&D Expenses on Firm Performance: A Comparison between Manufacturing and Services Companies in the United States December 2015 Author: Nikolaos Karakatsanis Student Number: 409742 Supervisor: Drs. Fytraki, A.T. Second Reader: Dr. Keusch, T. Accounting Auditing and Control -1- The Impact of Executive Compensation and R&D Expenses on Firm Performance: A Comparison between Manufacturing and Services Companies in the United States Abstract Using a panel of U.S. manufacturing and services companies over the 2000-2014 period, this study explores the relationships between executive compensation and firm performance, as well as, the relationship between R&D (research and development) expenses and firm performance. Moreover, this study presents a comparison of these relations between manufacturing and services companies. An Ordinary Least Squares (OLS) regression model was employed to estimate these relations, with control variables of size, total executive compensation and R&D expenses. My analysis revealed that executive compensation has a significant positive impact on the performance of manufacturing companies, but do not have an effect on the performance of services companies. Additionally, R&D expenses positively affect the performance of manufacturing firms, whereas they have a negative impact on the performance of services companies. Keywords: Executive Compensation, R&D Expenses, Firm Performance, Firm Size, Manufacturing Firms, Services Firms -2- The Impact of Executive Compensation and R&D Expenses on Firm Performance: A Comparison between Manufacturing and Services Companies in the United States Contents 1. Introduction .................................................................................................................... - 4 1.1 Research Problem & Motivation ................................................................................. - 4 1.2 Research Objectives .................................................................................................... - 5 1.3 Research Methodology ................................................................................................ - 7 - 2. Literature Review-Hypothesis Development ................................................................. - 8 2.1 Executive Compensation and Firm Performance ........................................................ - 9 2.2 R&D Expenses and Firm Performance ..................................................................... - 14 2.3 Interaction Effects...................................................................................................... - 17 - 3. Research Design........................................................................................................... - 21 3.1 Variables .................................................................................................................... - 21 3.1.1 Independent Variables ........................................................................................ - 21 3.1.2 Dependent Variable ............................................................................................ - 24 3.1.3 Control Variables ................................................................................................ - 25 3.2 Data Collection .......................................................................................................... - 25 3.3 Methodology.............................................................................................................. - 26 - 4. Empirical Results ......................................................................................................... - 26 4.1 Descriptive Statistics ................................................................................................. - 27 4.2 Pearson Correlation Matrix ....................................................................................... - 29 4.3 Main Findings ............................................................................................................ - 30 4.4 Interaction Effects...................................................................................................... - 32 - 5. Conclusion ................................................................................................................... - 34 5.1 Limitations and Future Research ............................................................................... - 36 - References .......................................................................................................................... - 37 Appendix ............................................................................................................................ - 45 - -3- The Impact of Executive Compensation and R&D Expenses on Firm Performance: A Comparison between Manufacturing and Services Companies in the United States 1. Introduction One of the most debated issues regarding executive compensation is the one examining the relationship between CEO compensation and firm performance. For more than seven decades this particular topic continues to concern the experts in the field of management control, while the related literature consists of more than three hundred studies (Barkema and Gomez-Mejia, 1998). Many authors have identified in their works a variety of factors that regulate the payperformance relationship. In particular, such factors are recorded firm size, firm risk, ownership structure, socio-cultural factors and demographic factors like executives’ age, tenure, education and gender. However, something that previous studies have in common and which operates as a limitation to further testing on the pay-performance sensitivity is that they focus on notable factors, whereas they ignore other unquantifiable, socio-cultural factors such as the type of services the firm provides. Therefore, this paper attempts to explain the nature of the relationship between executive pay and firm performance based on the diversity of businesses. Furthermore, research and development expenses are an issue with great importance for the economic development of companies, hence for the development of national economies. This importance may stem from the fact that for at least a century economic growth was driven by increasingly sophisticated technologies, which were developed to a great extent through R&D expenses (Greenstone, 2011). This importance, at least for the United States, also stem from the fact that a large proportion of R&D expenses are covered by governmental funds (Greenstone, 2011). 1.1 Research Problem & Motivation This modern era corporations have changed the way they pay their employees. Specifically, companies use more often incentives to motivate their executives and their employees than they did in the past. The reason for that is to induce them, so as to try harder in order to achieve a better performance. The basic fact that differentiates CEO and the other executives from the non-executives employees is the high of their compensation (including basic salary, bonuses and other compensation). This is happening because of the different responsibilities they have. Moreover, firms invest in innovation through R&D expenses in order to obtain an advantage over their competitors. The current study is quite relevant to the content of finance and specifically to management control which examines the numerous official mechanisms to influence the decision making process within organizations. Executive’s compensation and -4- The Impact of Executive Compensation and R&D Expenses on Firm Performance: A Comparison between Manufacturing and Services Companies in the United States the decision of the amount of investments in research and development are part of such mechanisms. It is observed by Murphy (1999) that CEOs in all countries and especially in the United States increase continuously their compensations, while worldwide economy faced many recessions and financial crisis during the second half of the past century. In many cases the performance of both services and manufacturing companies does not justify these payments. In their work, Friedman and Friedman (2010) state that the way of CEOs compensation and the conflicts of interest are the reasons of the catastrophic financial crisis after the Lehman Brothers collapse in 2008. Moreover, based on a Watson Wyatt survey, Kirkland (2006) found out that approximately 90% of institutional investors consider top executives to be dramatically overpaid for what they do. Therefore, it is praiseworthy to wonder if compensation systems work as they supposed to or not. Additionally, it would beneficiary to examine if executive compensation affects differently companies that belong in different industries. The last one could show that manufacturing and services companies might have better performance if they embrace different compensation packages for their executives. 1.2 Research Objectives There is a plethora of past papers that state the impact of executives’ compensation and R&D expenses on firms’ performance, which are referred in details in the literature review segment. The main objective of this study is to investigate the relations between the compensation of senior business executives (such as CEOs, CFOs and COOs) and firms’ performance on the one hand and R&D expenses and firms’ performance on the other hand. This investigation focuses on firms in the United States depending on the type of services they provide. More specifically, this thesis is going to observe if there is a different impact of executive compensation and R&D expenses on the total outcome of service enterprises (including banks and other financial firms) and manufacturing companies in the United States. All these are incorporated in the following main research question: RQ: Does executive compensation and R&D expenses have a stronger impact on the output of services firms than on manufacturing companies in the United States? As I will elaborate below, there are past researches that show the impact of executives’ compensation and R&D expenses on the performance of both services firms and -5- The Impact of Executive Compensation and R&D Expenses on Firm Performance: A Comparison between Manufacturing and Services Companies in the United States manufacturing companies in different countries. What makes my research question unique, is that aims to gather all of these information in a single work, so as to allow the comparison between these two different industries by focusing only in the United States economy. Providing an answer to this research question is very significant. More specifically, it could modernize compensation systems, especially for the executives based in which industry each company belongs. Additionally, this could improve companies’ operations; hence it could reduce costs and increase profitability. Last but not least, the results of this paper will give American shareholders a better insight about executive compensation and R&D investments. In details, it will be a helpful tool for the policy makers regarding the design of executive compensation systems on the one hand and the release of funds in favor of research and development on the other hand. The originality of my study lies in the fact that investigates an issue on which there is little or no relevant existing literature. Additionally, what is special about this paper is that it compares the compensation systems and R&D investments in different economic sectors to find the best possible financial mixtures that will maximize firms’ final performance. Since the purpose of this study is to examine the impact of executives’ compensation and R&D expenses on American firms’ performance based on the type of services they provide, I split the companies into two main categories: services companies and manufacturing companies. At this point, before I continue with my research, there is an imperative need to clarify some definitions. Firstly, by the term total output of a company I mean all goods and services that a company produces for a specific period of time. All the above contribute to form the firms’ profit. Subsequently, services companies are those companies comprising a wide variety of industries that do not produce anything but provide services and instead. Such companies are financial services firms (banks, credit card companies, insurance companies, accountancy companies, investment funds, real estate funds, etc.), retailers, accommodation industry, etc. Finally, manufacturing companies are those businesses that use raw materials to make a final product, which can be sold directly to consumers or to other manufacturing firms to make a different product, or to provide a certain service. Examples of such companies are vehicle manufacturers, construction developers, clothing companies, mining and oil-production companies, large conglomerate, etc. -6- The Impact of Executive Compensation and R&D Expenses on Firm Performance: A Comparison between Manufacturing and Services Companies in the United States Moreover, as stated previously, companies use incentives to compensate their executives. These incentives can be both monetary when they are based in equity-based compensation and non-monetary when they are based on behavioral characteristics. Examples of equitybased incentives are the total number of stock options granted, the total number of restricted shares granted, long-term incentive payouts, bonuses etc. On the other hand, examples of nonfinancial incentives could be the praise and commendation from immediate manager, the attention receiving from leaders and opportunities to lead projects. Finally, some things that need to be clarified are some of my choices regarding this project. My study focuses on firms in the United States for two main reasons: firstly, because of the size of US economy and secondly, because of the role of the United States as a leading figurecountry-economy of the developed world. Regarding my choice for these particular business sectors of the United States economy, is because the services and the manufacturing industry in their broader sense comprise the largest part of the largest economy in the world. In particular, the industrial sector made up 19.1 percent, while services constituted 79.7 percent of the United States GDP in 2012 (World Economy Team, 2013). 1.3 Research Methodology As a first step towards answering my research question, a thorough existing review of the relevant literature is conducted. Firstly, I have to present the past theoretical and empirical findings about executive compensation in general and the way executives are compensated in the United States in particular. Subsequently, I will focus on the structure of this compensation; that is the basic components based on which executives are getting paid and their development through the decades. After that I will make a distinction of the previously referred subjects between different business sectors and more precisely between the services sector (including banks and other financial institutions) and the manufacturing sector, comprising mainly of companies belonging in the automotive industry, mining and aerospace companies, etc. Secondly, I have to present the existing literature that is relevant to research and development (R&D) expenses in general, their use from U.S. companies and their impact on both manufacturing and services companies. Finally, another stream of literature that I will examine is which specific metrics could act as control variables that affect the examined relations. After that, I will collect my data which I will extract from the Wharton Research Data Services system. For my research, I will need annual data for executive compensation for -7- The Impact of Executive Compensation and R&D Expenses on Firm Performance: A Comparison between Manufacturing and Services Companies in the United States companies in the United States that are available through the COMPUSTAT ExecuComp Annual Compensation database. Moreover, for the annual data about R&D expenses and ROA (firm performance) I will use the COMPUSTAT Fundamentals Annual database. The same database I will use to extract data about sales turnover which I will use to measure the control variable of firm size. Lastly, I will compare the impact of executive compensation and R&D expenses on firm performance for all the U.S. manufacturing and services companies. My sample period is from 2000 until 2014. The main findings of my research reveal a significant positive association between executive payments and the performance of manufacturing companies. On the contrary, there is not an association between executive payments and the performance of services companies. Moreover, the analysis showed that research and development expenses have a positive impact on the performance of companies belonging to manufacturing sector. In contrast, the impact of R&D expenses on the performance of services companies is negative. Also, the impact of executive compensation on firm performance is more intense in manufacturing than in services companies. In addition, the impact of R&D expenses on firm performance is bigger in manufacturing than in services companies. Finally, the results show that the interaction effects between executive compensation and firm size and R&D expenses and firm size is positive for both manufacturing and services firms (except for the interaction of executive payments and firm size in services companies, which does not apply at all). The paper is organized as follows. In the next section, there is a thorough presentation of the literature that is related to both the executive compensation-firm performance relation and the R&D expenses-firm performance relation. In the same section, the construction of the research hypotheses is made. This is followed by the research design that includes data collection and methodology. Then, my findings and the basic conclusions are presented, followed by the research limitations and some recommendation for further research. 2. Literature Review-Hypothesis Development In this section there is an attempt to collect and present all the past theoretical and empirical studies which are relevant to the relationship between executive compensation and firm performance on the one hand and R&D (research and development) expenses and firm performance on the other hand. For this purpose, there has been an overview of published, working and research papers and an endeavor to be used both the market and accounting ways -8- The Impact of Executive Compensation and R&D Expenses on Firm Performance: A Comparison between Manufacturing and Services Companies in the United States to measure firm performance. To choose which papers should be discussed, I used mainly those that are included in the top ten accounting journals as they ranked in both the British and the Australasian rankings. I did that because I consider it as the best way to support the ideas that my thesis promotes. Additionally, there has been an extensive use of Google Scholar, so as to find other relevant papers. Also, I choose to use papers that on average cover chronologically a period of two decades, so as to observe the changes in both practice and theory of the pay-performance sensitivity and the performance-R&D expenses relationship throughout the years. 2.1 Executive Compensation and Firm Performance To begin with, my dissertation is connected to the literature that gives information about the association between executive compensation and firm performance. But before investigating the above relation it is crucial to observe the importance of executive compensation as it is an issue that gathered a lot of attention for over five decades around the globe and in the United States in particular. Several factors triggered this extensive interest, factors that are undoubtedly associated with the change of executive compensation. In their study, Frydman and Saks (2010) examined the profound change in the level of executive payments during a long period of time from 1936 to 2005. More precisely, after a sharp drop during WWII, the level of payments increased slowly from the mid-1940s to the mid-1970s, but they increased rapidly from the 1970s to the present. But which reasons lead to this change? Murphy (1999) tries to answer this question by citing some factors that cause the previously referred fact. Firstly, chief executive officers (CEOs) obtained more power in the board of directors which lead to the continuous rise of their compensation. Secondly, during 1980s, it was believed widely that the high payments of CEOs lead to plant closures and proliferation of layoffs which in turn lead to a corporate downsizing. Finally, during 1990s it was observed a tight bond between the payments of CEOs and the stock price performance of the companies. Furthermore, the importance of executive compensation is illustrated also by the unbreakable link to firm performance. At this point, it is of great importance to observe if there is an interaction between these two components. More precisely, it is crucial to be examined if executive compensation affects firm’s performance and parallel it is affected by this. -9- The Impact of Executive Compensation and R&D Expenses on Firm Performance: A Comparison between Manufacturing and Services Companies in the United States To begin with, Doucouliagos et al. (2007) showed in their paper that executive compensation and performance of Australian banks are not related when the period is one lag. However, this relation seems to exist when there is a period of two lags and more. Zhou et al. (2011) showed that neither, there is a relation between managers’ compensation and bank’s performance, nor compensation changes influence firm performance. However, the pay-performance sensitivity that is examined in this study is lowered by the state control ownership of Chinese banks. Similarly, in their work, Firth et al. (2006) found that in firms in which the state holds the majority of shares, pay-performance sensitivity does not exist, whereas firms in which private equity holders or SOEs represent the major shareholders appear to have a stronger payperformance link. Wei (2000) tested 765 listed companies and found no significant positive association between firm performance and executive compensation. In Japan during the period from 1977 to 2000, Kubo and Saito (2008) examined the pay-performance sensitivity and they found that it decreased substantially after 1990 due to bureaucracy. Relevant to this, is the agency theory which describes the association between two parties: the principal (shareholders) and the agent (executives). This relationship happens when shareholders hire managers to do the day-to-day business in the company. For example, the chief executive officer (CEO) possesses the highest position among executives in a company and is the one who makes all the important decisions. These decisions may be about policy and strategy, expansion, acquisitions, etc. The chief operating officer (COO) is responsible for the day-to-day operation of the company. Finally, the chief financial officer (CFO) of a firm is responsible for the financial planning and other similar staff. According to this theory there is not an alignment of shareholders’ interest with those of executives. Specifically, executives regardless whether they are working in the services or the manufacturing industry, desire to maximize their wealth whether firm performance is good or bad. This, in most cases, contrast shareholders’ interests. On the other hand, there is past literature that points out the effect of executive compensation on the firm performance based on several factors. Specifically, Wallsten (1999) in his empirical work found that executive compensation is linked to firm’s performance and in fact this link is growing stronger based mainly on the executive’s rank in the company. On the contrary, firm’s performance seems to have no effect on executive payments, as executives are rewarded in profitable years but are not punished in non-profitable years. Similarly, Gaver and Gaver (1998), Iyengar (2000) and Shaw and Zhang (2010) stated that executives are not - 10 - The Impact of Executive Compensation and R&D Expenses on Firm Performance: A Comparison between Manufacturing and Services Companies in the United States punished in poorly performing years because the board of directors is reluctant to that, showing that pay-performance sensitivity does not apply in poorly performing years. Coughlan and Schmidt (1985) in their work focused among others on the significant relation between rates of change in pay and firm performance as it is depicted by the stock price performance. Likewise, Frydman and Jenter (2010) pointed out that this relation between executive pay and stock price performance increased more intensively in the 90’s. Brick et al. (2006) were more precise on this subject as they evidenced that overcompensation of directors and CEOs has a negative impact on firm performance and lead to underperformance. Moreover, there is further past literature that points out the existence of relation between executive’s compensation and firm performance. According to previous researches, this relation might be either positive or negative. The majority of the researchers in one way or another found a positive effect of executives’ payments on firm’s performance. Among them are Mehran (1995) and Hubbard and Palia (1995) who both in their work found that executive’s compensation influences firm’s performance; the former by examining the executive compensation structure of 153 randomly-selected manufacturing companies between 1979-1980 , whereas the latter by testing 147 banks during 1980. The option valuation model as being modified by Merton (1973) to include also firm dividends was used by Black and Scholes (1973), Core and Guay (2002) and Daniel et al. (2013). According to Manmohan and Mukund (1988) the relationship between executive compensation and firm performance is characterized by complexity, but they found that there is a positive relation by examining the changes in CEOs’ compensation in 1985 and 1986. In addition, Sun et al. (2013) stated that firm performance and CEOs’ compensation are associated, when performance is measured in terms of revenue efficacy. To test their hypothesis, they used a sample of United States property-liability companies from the insurance industry. Moreover, Zajac (1990) stressed that there is a strong connection between executive compensation and firm performance, as companies in which CEOs align their personal wealth to the wealth of the shareholders, hence their firms, tend to be more profitable. To extract his findings, the author used data for CEOs from the Forbes 500, the Fortune 500 largest industrial firms and large firms with annual sales of one billion dollars that are not listed in Forbes 500 in 1987. In their work, Canarella and Gasparyan (2008) found a positive relation between executive compensation and firm performance. They used a sample of computer and software companies from 1996 to 2002. - 11 - The Impact of Executive Compensation and R&D Expenses on Firm Performance: A Comparison between Manufacturing and Services Companies in the United States On the contrary, there is literature like the work of Chen and Jermias (2014) which stated that firm’s performance is negatively affected by executive’s compensation, when this certain compensation policy is not in line with the business strategy of the firm. Based on these facts, I constructed the following hypotheses: H1a1: Executives’ compensation has a significant positive association with the performance of a manufacturing company in the United States. H1b1: Executives’ compensation has a significant positive association with the performance of a service company in the United States. Another stream of literature that is relevant to my thesis is the one that regards executive compensation in firms which are based in the United States. As I mentioned before, the importance to examine the impact of executives’ compensation on firms’ performance partly lies in the size of the United States economy, so as the results can be more visible. Besides the above, the leading role that the United States play in the “Western”, developed world is of great importance for this study’s results, in the sense that if these results are applicable in the world’s largest economy they will be applicable everywhere. In the relevant literature, Bebchuk et al. (2001) referred that CEOs in the United States were compensated more compared to their colleagues in other countries. According to them, various factors lead to this phenomenon. As example they pointed out the larger influence of American CEOs compared to foreigners CEOs. Moreover, they suggested that the American market is characterized by bigger competition, which lead American CEOs to get paid more than their counterparts in other countries. Next, to understand better the relation between the executives’ payments and firms’ performance, it would be beneficiary to examine the exact structure of the executive compensation. As I stated in the introduction companies in modern economies exploit the use of incentives to compensate their executives and to induce them, so as to succeed larger profits. The type of incentives depends on whether they are based in equity-based compensation or on behavioral characteristics; the former are pecuniary incentives, whereas the latter are non-pecuniary incentives. - 12 - The Impact of Executive Compensation and R&D Expenses on Firm Performance: A Comparison between Manufacturing and Services Companies in the United States In his work, Murphy (1999) stated that despite the different compensation systems that companies may use, managers are getting paid mainly in four different ways: the basic salary, the short-term incentives, the long-term incentives and the perquisites. This composition has changed as well following the change in the magnitude of executive compensation. In particular, since 1950 executive payments changed significantly, as forms of incentive payments became the larger parts of the total compensation (Frydman and Saks, 2010). Also, Mehran (1995) in his empirical work stressed that companies in which managers own shares perform better. Likewise, Core et al. (2003) pointed out that is better for firm performance if executives are also owners of the companies they work, by holding certain equity. In her study, Frye (2004) suggested that firms which use compensation systems based on equity for their employees (executive and non-executive perform better. It is also interesting to observe that the exact structure of executive compensation could be related to the composition of the board of directors. In details, it is a common fact that firms with more outside directors tent to compensate their executives with a higher percentage of equity-based forms of payments (Mehran, 1995). Moreover, there is existing literature that focuses on the impact of executive compensation on firms of two specific industries; the services companies and manufacturing companies. My expectations to find different results between these two sectors lie in the important role that the finance industry plays, as the most significant pillar in every country’s economy. But is there actually any possibility of having different results between different industries? And if yes, which are the characteristics that differentiate each industry from the other and lead to these results? According to Zhou et al. (2009) “services companies differ from manufacturing in labor intensive, in intangibility, in service heterogeneity, in customer involvement, in customersupplier duality, in simultaneity of production and in consumption”. The financial sector (Services Industry) differs from other industries in its complexity which can lead to a greater impact of executive compensation on the firm’s performance of financial institutions than in other companies (Macey and O’Hara, 2003; Doucouliagos et al., 2007; John and Qian, 2003). The aforementioned complexity exists because of the special role that the financial institutions have, regarding the progress of American markets and worldwide markets in general. By this I mean that banks and other companies in the finance industry are the main pillars in any economy as they supply with funds all other business sectors. - 13 - The Impact of Executive Compensation and R&D Expenses on Firm Performance: A Comparison between Manufacturing and Services Companies in the United States However, financial institutions are regulated at a higher degree than manufacturing firms (John and Qian, 2003) and this regulation is an alternative way of monitoring and a way of providing incentives to managers (Hirschey and Pappas, 1981; Carroll and Ciscel, 1982). Based on this regulation, the pay-performance sensitivity in financial institutions is expected to be lower than it is in manufacturing companies. John and Qian (2003) stressed also that pay-performance sensitivity in the banking industry is lower than it is in the manufacturing industry because of its high leverage. Now based on these arguments I will construct the hypotheses that will help to compare and contrast the impact of executive compensation on companies in the service industry and in the manufacturing industry. More specifically: H2: The significant positive association of executives’ compensation with firm performance is bigger in manufacturing than in services companies in the United States. 2.2 R&D Expenses and Firm Performance Secondly, the importance of R&D (research and development) expenses should not be considered less significant, as it is a core part of the modern business world. Businesses often use research and development for future growth by emerging new products or processes, in order to increase and advance their operations. Although R&D expenses are a synonymous with high-tech companies, many firms from all industries spend large amounts of money to improve their products/services. Ericson and Jacobson (1992) stressed that firms in order to obtain an advantage over their current or future competitors make use of R&D expenses. In this way, they manage to prevent imitations and to increase substantially their profits. Similarly, Hayes and Abernathy (1980) claimed that superior technologically products will help firms to succeed and to gain an edge over their rivals. Additionally, Chao-Hung Wang (2011) focused on the survival of firms in such a competitive environment and explained that R&D expenses can play a significant role in it. In particular, he pointed out that R&D expenses are outweighed by the benefits they have in innovation and performance. In his work, Drucker (2005) pointed out that firms should increase their R&D investments in order to gain in competitiveness. Another fact that demonstrates the importance of R&D expenses is the existence of RJV (research joints ventures) which are created based on a cooperative agreement between firms - 14 - The Impact of Executive Compensation and R&D Expenses on Firm Performance: A Comparison between Manufacturing and Services Companies in the United States that share the costs and the results of the research project. Specifically, the importance seems from the fact that firms which may be competitors in an industry, cooperate in R&D investments in order to minimize the costs and maximize the potential profits. According to Siebert (1996), firms that cooperate in R&D expenses show higher profitability. Similarly, Motta (1992) showed that a cooperative R&D has a higher welfare level than a noncooperative one. In the same range, Rosenkranz (1995) stressed that firms choose to cooperate in their R&D expenses, because otherwise their profitability will be low or even zero due to the uncertainty of their rival’s strategy. On the contrary, Choi (1993) suggested that this kind of cooperation depends on the spillover rates and when these rates are high a cooperative R&D is more preferable than a non-cooperative one, but the profit decreases. The reason for that is the intensified competition that lies in the post-innovation period. Next, there is the literature that shows if there is a positive or negative relationship between R&D expenses and firm performance. In their work, Cooper et al. (2008) found a positive relation between R&D expenses and firm performance in terms of future returns. Similarly, Lev and Sougiannis (1999) found that R&D expenses become risk factors when they are added to a firm’s capitalization and they have a positive impact on firm’s future returns. Hirschey and Weygandt (1985) stressed that corporate expenses for innovation (R&D) need a period of five to ten years to have a deferred effect. In addition, Toivanen et al. (2002) showed that R&D investments positively affect market value. Liang and Zhang (2005) and Cheng et al. (2006), by examining samples of 72 and 96 high technology companies respectively, found also a positive relationship. However, there must be the appropriate understanding and management of the knowledge produced by R&D investments, in order to lead to an increase in firm’s future performance. On the contrary, there are past papers that reveal no or negative relationship between R&D expenses and firm performance. Donelson and Resutek (2012) claimed that expenses in research and development and firm’s profits are not related. Hsu et al. (2013) showed that R&D expenses increase net sales, but also increase operating costs which tend to decrease operating income. Finally, Cooper et al. (2008) suggested that there is a negative relation between R&D expenses and firm’s earnings when this relation is examined from finance perspective, but it is positive in accounting. Based on these facts, I constructed the following hypotheses: - 15 - The Impact of Executive Compensation and R&D Expenses on Firm Performance: A Comparison between Manufacturing and Services Companies in the United States H1a2: Research and development expenses have a significant positive association with the performance of a manufacturing company in the United States. H1b2: Research and development expenses have a significant positive association with the performance of a service company in the United States. Another stream of literature that is relevant to my thesis focuses on the use of R&D expenses by American companies. It is interesting to observe how these companies consider investments in R&D given that in the United States have their headquarters some of the largest, most profitable and influential manufacturing and services firms in the world. To begin with, Greenstone (2011) pointed out the importance of R&D expenses for the United States, explaining that for at least a century America faced a continuous economic growth due to innovation, which in turn increased the standard of living. Research and Development investments lead to this innovation and to the competitiveness of the U.S. economy. Another fact that reveals the importance of R&D expenses is that both the private and the public sector spend large amounts of money on such investments (Greenstone, 2011). In a comparative analysis between French and American manufacturing firms, Mulkay et al. (2000) found that in U.S. firms the effect of cash flows and profits on R&D investments is more intense. That practically means that in the United States it is easier to get access to funding for research and development. Furthermore, there is existing literature that focuses on the impact of research and development expenses on firms of specific industries, such as manufacturing companies and non-manufacturing companies. The latter are companies that do not produce anything and therefore they may call services companies (including financial services companies). Ehie and Olibe (2010) stressed that companies from different industries tend to approach differently R&D expenses and to make use of different mixtures, in order to achieve their goals. Specifically, manufacturing companies want to improve their production systems through these investments, whereas services companies use R&D expenses for other developments. Likewise, Mansfield and Lee (1996) stated that manufacturing companies may be significantly benefitted by investments in R&D, since these investments can improve the production, and hence can minimize the production costs. Ho et al. (2005) examined the - 16 - The Impact of Executive Compensation and R&D Expenses on Firm Performance: A Comparison between Manufacturing and Services Companies in the United States impact of R&D expenses on firm performance in both manufacturing and services companies for a one-year lag. They found that the performance of manufacturing firms was positively affected in contrast with the performance of services companies. Based on these facts, I constructed the following hypothesis: H3: The significant positive association of research and development expenses with firm performance is bigger in manufacturing than in services companies in the United States. 2.3 Interaction Effects Finally, there is the literature that is relevant to which metrics could be used as control variables in the executive compensation and firm performance relation on the one hand and in the R&D expenses and firm performance relation on the other hand. There is a plethora of past papers that are referred to firm size1 as a control variable, meaning that affect both the executive compensation and the firm performance. Consistent with previous studies Cyert et al. (2002) found out that firm size is the most important explanatory variable for all forms of executive compensation. Likewise Hubbard and Palia (1995) showed the positive relation between the size of financial institutions and their executive compensation. Besides all these, it is observed that in large companies the productivity growth rate is linked to the firm size as it is shown by its working capital, the number of employees, the amount of tangible assets and its sales (Halkos and Tzeremes, 2007). However, there are researchers who stress that pay-performance sensitivity should be inversely related to firm size. More specifically, political influence could lead to lower payperformance sensitivity in large firms (Jensen and Murphy, 1990). Moreover, Schaefer (1998), by using a model and empirical evidence, argued that pay-performance sensitivity drops when firm size rises. Based on these arguments, I constructed the following hypothesis: H4a: The impact of executives’ compensation on the performance of a manufacturing company in the United States should be greater in larger firms. 1 Firm size is used as control variable when testing H1-H3, while is used as moderator variable when testing the interaction effects in H4-H5. - 17 - The Impact of Executive Compensation and R&D Expenses on Firm Performance: A Comparison between Manufacturing and Services Companies in the United States H4b: The impact of executives’ compensation on the performance of a service company in the United States should be greater in larger firms. There is also a plethora of past literature that includes firm size as a control variable when testing the relationship between R&D expenses and firm performance. To begin with, Crépon et al. (1998) found a significant correlation between firm size and R&D expenses. Similarly, Hsu et al. (2013) stressed a positive relationship between firm size and R&D expenses. Ehie and Olibe (2010) showed that R&D expenses positively influence firm performance after controlling for firm size. Finally, Ayaydin and Karaaslan (2014) found that firm size has a positive impact on the profitability of companies. Based on the above, I constructed the following hypothesis (here firm size is used: H5a: The impact of research and development expenses on the performance of a manufacturing company in the United States should be greater in larger firms. H5b: The impact of research and development expenses on the performance of a service company in the United States should be greater in larger firms. Additionally, R&D expenses and executive compensation could be used as control variables to see their influence on the relationship between executive compensation and firm performance and R&D expenses and firm performance respectively. According to Cheng (2004), there is a positive association between changes in R&D expenses and changes in CEOs’ total annual compensation, when CEO is about to retire (horizon problem) and when firms face small earnings reduction (myopia problem). On the contrary, Bizjak et al. (1993) found a negative association between R&D expenses and CEO’s compensation. One possible explanation for these contradictory findings is the danger of overinvestment in R&D expenses, which makes it unclear for the compensation committees, if they should motivate more R&D spending. Artz et al. (2010) showed that there is a positive impact of R&D expenses on firm performance. Moreover, researchers like Salavou (2002) and Prajogo (2006) stated that product innovation as a result of R&D expenses leads to firm growth and performance increase. Similarly, in their works Roberts (1999) and Cho and Pucik (2005) stressed a very positive association between innovation as a result of R&D expenses and performance of manufacturing firms in the United States. Last but not least, there are few - 18 - The Impact of Executive Compensation and R&D Expenses on Firm Performance: A Comparison between Manufacturing and Services Companies in the United States sources that indicate spending for research and development in the banking industry. Thomke (2003) pointed out the experiment conducted by the Bank of America, one of the leading U.S. banks, which has been running a series of ongoing R&D processes to create a new service concept for retail banking. The results show a significant increase in the performance of the bank. Finally, the board of directors that is responsible for the level and the composition of executive payments could be another control variable to test how it affects the relation between executive compensation and firm performance. Specifically, Doucouliagos et al. (2007) found out that there is a positive relation between the directors’ and the CEO’s compensation. Also as it is referred above, when the majority in the board of directors is outsiders, executives tent to be compensated basically with equity (Mehran, 1995). This fact points out that the board of directors play a key role in the setting of compensation systems. Lastly, CEO compensation monitoring is related to firm performance and this relationship get stronger when firms are controlled by management rather than by their owners. After studying the already existing literature, I have found significant evidence that will contribute to complete this particular survey. First of all, there is a plethora of previous researches that examining the impact of executives’ compensation and R&D expenses on firms’ performance. Initially, the vast majority of studies related to executive compensation and firm performance show that there is a strong relationship between them. However, there are some exceptions where this link does not exist. More specifically, it is observed that in countries such as China in which the government has a significant influence in many companies (including banks), executives’ compensation does not affect firms’ performance at all (Zhou et al., 2011). Furthermore, there is extensive literature about how this relation is applied in the United States. There is also past literature related to the impact of executive compensation on firm’s performance in both the finance and the manufacturing industry. Continuously, most of the literature regarding R&D expenses and firm performance reveal a strong positive relation between them with some exceptions. Following, there is literature relevant to the use of research and development expenses in the United States. Last but not - 19 - The Impact of Executive Compensation and R&D Expenses on Firm Performance: A Comparison between Manufacturing and Services Companies in the United States least, there are past researches that investigate the impact of R&D expenses on manufacturing and non-manufacturing firms. As far as control variables are concerned, I choose to use firm size because it has been previously shown to have an effect on both the relations I am testing. Moreover, I choose to use R&D expenses and executive compensation as control variables when executive compensation and R&D expenses stand as my independent variables respectively. I did that because R&D expenses are used to boost firm’s performance and as a competitive advantage against competitors. Also many times they are manipulated so as to have an impact on executive’s compensation (Cheng, 2004). All these are important for my thesis as they will help me to interpret this study’s final findings and possibly to add something new in the standing literature. However, I have found no literature comparing the impacts between these two industries. For this reason this work is important. Firstly, it can add to the existing literature regarding executives’ compensation and firms’ performance on the one hand and R&D expenses and firms’ performance on the other hand. Secondly it has important implications in both theory and practice. Regarding the theory, this study offers important information in the content of management control that has to do with decision making on administrative issues. Such issues are executives’ compensation and their structure. This paper has also some important practical implications. In particular, it can assist companies by modernizing their executive compensation systems and by improving their operations. Moreover, it points out the importance of R&D expenses for companies as far as their economic progress and their competitiveness are concerned. My thesis contributes to the already existing literature that is relevant to the impact of executive compensation and R&D expenses on firm performance by examining and comparing these relationships between companies from the services sector and the manufacturing sector. Based on the existing literature I expect a strong impact of executive compensation and R&D expenses on firm’s performance. Moreover, I expect the relation of executive compensation on firm performance to be stronger for companies in the manufacturing sector than for companies in the services sector. Similarly, I expect that the impact of R&D expenses on firm performance will be greater on manufacturing than on services companies. - 20 - The Impact of Executive Compensation and R&D Expenses on Firm Performance: A Comparison between Manufacturing and Services Companies in the United States 3. Research Design In this section, I will present and further elaborate the basic components-variables that I intend to use in order to examine the research question of this thesis. More specifically, I will elucidate what is and how I am going to measure firm performance, executive compensation, R&D expenses and firm size. Moreover, in this section I will give information about data collection. Finally, I will explain all about the methodology and the basic model I will use. 3.1 Variables A complete presentation of all the variables is available in Table 1 in the Appendix. 3.1.1 Independent Variables In this study, the independent variables are CEO remuneration and R&D expenses. CEO Remuneration The already existing literature provides little guidance for empirical researchers on determining in the most appropriate way the compensation of executives and especially CEOs. Most studies use nothing but a market or accounting measure of performance to calculate executives’ payments. But how shall we determine the payments of business executives? To understand this issue better and thus to find the most suitable answer, we should determine first what is executive compensation and what components on average may constitute such a compensation. As stated in the introduction, companies in the modern economic environment compensate their executives by using different incentives, so as to make them perform better by securing and increasing shareholders’ wealth. Depending on whether the incentives are equity-based or behavior-based, they are divided into two categories: the monetary and non-monetary incentives. Both these categories have a common goal, which is rewarding employees for doing their job well, but it is slightly different based on what they are designed to achieve. More specifically, monetary incentives are something that employees can struggle for, in contrast with non-monetary incentives. Another way to classify and understand the compensation of executives is to distinguish it in the four main categories that compose it. These main components are the basic salary, shortterm incentives, long-term incentives and perquisites: - 21 - The Impact of Executive Compensation and R&D Expenses on Firm Performance: A Comparison between Manufacturing and Services Companies in the United States Basic salary The basic salary is considered a “fixed” element of executives’ payments and usually it is not affected by the company’s performance. Short-term incentives Short-term incentives or annually awarded incentives are used to compensate executives for achieving the company’s short-term business goals set by the board. These types of incentives are mostly financial metrics in the form of bonuses. However, many companies tend to use non-financial metrics as well. In most cases executives in higher-level positions receive higher of these award opportunities and vice versa. Finally, short-term incentives are usually planned to provide minimum, desired and maximum levels of performance which are used to create minimum, desired and maximum levels of payment. Long-term incentives Long-term incentives are mixtures of equity and cash compensation that is used to reward executives for achieving the company’s long-term goals that will increase shareholders’ wealth. Examples of long-term incentives which are referring to a performance period that usually is between three to five years are restricted stocks, shares, stock options, etc. Long-term incentive objectives differ among companies but most of the times are focused on return measures (return on assets) and operational measures (earnings per share). In any case executives do not receive any further payment (from the incentives), but in the end of the specific period. Similar to annual incentives, long-term incentives are usually designed to have minimum, desired and maximum levels of performance. Finally, these kinds of incentives are considered an important part of executives’ compensation because they are the largest part of it (over 60 percent for the median S&P 500) and they guarantee an alignment with the shareholder interest. Benefits/Perquisites The last component of executives’ total compensation package consists of a wide variety of benefits and perquisites or “perks”. This form of compensation is used to recognize how important to the company each executive is and include company cars, club membership, spouse travel, housing accommodation etc. - 22 - The Impact of Executive Compensation and R&D Expenses on Firm Performance: A Comparison between Manufacturing and Services Companies in the United States Because of the complexity to quantify and measure benefits such as “perks” due to lack of reliability of data, this paper following past studies will focus solely on monetary incentives. Moreover, they tend to be more effective and influential than other non-monetary incentives. Research and development (R&D) expenses Another independent variable in this study is research and development expenses (R&D). R&D expenses are a type of tax deductible operating expense, used to find and create new products and/or services. These expenses can be of both minor and major significance especially for large corporations. The already existing literature gives contradictory results regarding the association between executive compensation and R&D expenses. According to Cheng (2004), this is happening because compensation committees based on the fear of overinvestment in R&D hesitate to allow further expenditures in the field of research and development. Furthermore, there is extensive literature that shows the impact that R&D expenses have on firm performance especially in the manufacturing industry. For example, DeCarolis and Deeds (1999) and Hua and Wemmerlov (2006) pointed out the positive effect that innovation through R&D expenses has on the performance of U.S. manufacturing firms. Likewise, Wakelin (2000) showed the significant effect that R&D expenses have on the performance of manufacturing firms in the United Kingdom. There are three types of R&D. These are the following: Basic Research: This kind research that applies to the industrial sector improves the scientific knowledge without any specific commercial purposes. However, such research may be in the interest to the company, present or future. Applied Research: Industries use this type of research to gain new knowledge about products, processes and services, with specific commercial purposes. Development: Development is the systematic use of obtaining knowledge or understanding through research to the production of products, systems or methods (with the design and development of prototypes to be included). - 23 - The Impact of Executive Compensation and R&D Expenses on Firm Performance: A Comparison between Manufacturing and Services Companies in the United States 3.1.2 Dependent Variable In this study, the dependent variable is firm performance. Firm Performance What is firm performance depends on how someone perceives the term “firm performance”. That is for example when someone uses marketing, operations, finance, human resource management, productivity, profitability or another metric to answer this question. In general, as firm performance could be considered the total output of a company; that is, all goods and services that a company produces for a specific period of time which leads to the firms’ profit. There is extensive literature that presents several measures of a company’s performance, both market-based and accounting-based. One difficulty that comes with comparing firm performance between different industries is the different metrics they use to do it. In particular, banks and manufacturing firms may use different ways to measure their performance. For example, banks can use non-performing loans (NPL) to measure their performance as this can increase the competitiveness within the banking system (Zhou et al, 2011). On the other hand, manufacturing firms may use their productivity or return on sales (Firth et al, 2006; Mengistae and Xu, 2002) as metrics. To avoid this problem, it is necessary to find a metric that can be used by both financial institutions and manufacturing companies. There are many conventional measures that can be used for companies in both the finance and the manufacturing industries. For example Brick et al. (2008) used stock returns, while Buck et al. (2008) total shareholder returns, pre-tax profits and returns on assets. Return on assets (ROA) and return on equity (ROE) are used extensively for the assessment of the performance of financial institutions (Knapp et al, 2005; Choi and Hasan, 2005; Shen and Chang, 2006) only in terms of profitability. Moreover, they are performance metrics that can be used to compare the performance of banks and manufacturing firms (Mishra and Nielsen, 2000). Although ROE is the prevalent measure of firm performance, it can obscure some potential difficulties. For example, some companies may increase their debt leverage levels to keep their ROE falsely healthy. This could increase significantly risk with worse results for such companies. On the contrary, ROA is a better metric of financial performance, as distortion such as mentioned before (Brown et al., 2010). In my thesis, I choose to measure firm performance in terms of ROE and ROA. - 24 - The Impact of Executive Compensation and R&D Expenses on Firm Performance: A Comparison between Manufacturing and Services Companies in the United States 3.1.3 Control Variables In this study, control variables are firm size, R&D expenses and executive compensation. Firm size Firm size is an important control variable that influences the payments of CEOs, a relationship that is examined extensively by many researchers (Jensen and Murphy, 1990; Gregg et al., 1993; Bliss and Rosen, 2001). It is expected that managers in larger firms will receive higher payments because of the higher degree of complexity of their duties. Every industry has an optimal firm’s size based on its particular production technologies, including capital intensities and scale economies (Kumar et al., 2001). All executive compensation relevant literature includes firm size as a control variable, but measures it in different ways. For example, Mishra and Nielsen (2000) used total capital, while Mengistae and Xu (2002) used current sales. Furthermore, Brunelloa et al. (2001) used both revenue and employment as size measures. This study uses the logarithm of sales turnover to measure size. 3.2 Data Collection The data used in this study were collected from Wharton Research Data Services system. More specifically, our data consists of all manufacturing and services firms listed on the COMPUSTAT ExecuCOMP Annual Compensation Database and the COMPUSTAT Fundamentals Annual files from 2000 to 2014. To measure executive compensation, I used total compensation (TDC1) which includes salary, bonus, other annual, total value of restricted stock granted, total value of stock options granted (using Black-Scholes), long-term incentive payouts and all other total. To measure R&D expenses, I used all costs incurred during the year that relate to the development of new products or services (XRD). For measuring firm performance, I used ROA by dividing net income (NI) with total assets (AT). Finally, to measure firm size, I used net sales turnover (SALE). The impact of executive compensation and R&D expenses on firm performance for all U.S. manufacturing and services firms (including banks and other financial services companies) is compared. I selected the companies based on their SIC (Standard Industrial Classification) code. Particularly, I used all manufacturing firms that have a SIC code between 2000 and 3990 (analytical manufacturing companies with their SIC codes are listed in Table 2 in the Appendix) and all services companies that have a SIC code between 6012 and 8900 (analytical services companies with their SIC codes are listed in Table 3 in the Appendix). Lastly, my sample period is from 2000 until 2014, as I want to examine this effect in this time - 25 - The Impact of Executive Compensation and R&D Expenses on Firm Performance: A Comparison between Manufacturing and Services Companies in the United States during which took place some of the most important political, economic and more events. For example, the September 11 attacks in 2001 which shook among others the U.S. economy, the introduction of the euro in 2002 as a competitive to the dollar currency and the 2008 Global Financial Crisis. 3.3 Methodology In this section I will present how I am going to test my hypotheses about the relationship between the executive compensation and firm performance on the one hand and R&D expenses and firm performance on the other hand. My model is based on the basic model analysis of compensation (Doucouliagos et al., 2007; Zhou et al, 2011), which is an Ordinary Least Squares (OLS) analysis. This will be used to run the following regression: 𝑃𝐸𝑅𝐹𝑖𝑡 = 𝛽0 + 𝛽1 ∗ 𝑆𝐼𝑍𝐸𝑖𝑡 + 𝛽2 ∗ 𝑅&𝐷𝑖𝑡 + 𝛽3 ∗ 𝑃𝐴𝑌𝑖𝑡 + 𝜀𝑖𝑡 where 𝑃𝐴𝑌𝑖𝑡 and 𝑅&𝐷𝑖𝑡 represents the executive compensation and the research and development expenses for company i (manufacturing or services company) in year t. 𝑆𝐼𝑍𝐸𝑖𝑡 represents the size of each company measured in terms of sales turnover (operating expenses). 𝑃𝐸𝑅𝐹𝑖𝑡 represents the performance of each company i in year t. Finally, 𝜀𝑖𝑡 represent the error term. Additionally, to measure the interaction effects in H4a-H5b, I will modify my regression model, so as to include the interaction terms: 𝑃𝐸𝑅𝐹𝑖𝑡 = 𝛽0 + 𝛽1 ∗ 𝑅&𝐷𝑖𝑡 + 𝛽2 ∗ 𝑃𝐴𝑌𝑖𝑡 + 𝛽3 ∗ 𝑆𝐼𝑍𝐸𝑖𝑡 + 𝛽4 ∗ 𝑃𝐴𝑌𝑖𝑡 ∗ 𝑆𝐼𝑍𝐸𝑖𝑡 + 𝜀𝑖𝑡 𝑃𝐸𝑅𝐹𝑖𝑡 = 𝛽0 + 𝛽1 ∗ 𝑃𝐴𝑌𝑖𝑡 + 𝛽2 ∗ 𝑅&𝐷𝑖𝑡 + 𝛽3 ∗ 𝑆𝐼𝑍𝐸𝑖𝑡 + 𝛽4 ∗ 𝑅&𝐷𝑖𝑡 ∗ 𝑆𝐼𝑍𝐸𝑖𝑡 + 𝜀𝑖𝑡 where 𝑃𝐴𝑌𝑖𝑡 , 𝑅&𝐷𝑖𝑡 , 𝑆𝐼𝑍𝐸𝑖𝑡 , 𝑃𝐸𝑅𝐹𝑖𝑡 and 𝜀𝑖𝑡 represent the same as before. 𝑃𝐴𝑌𝑖𝑡 ∗ 𝑆𝐼𝑍𝐸𝑖𝑡 and 𝑅&𝐷𝑖𝑡 ∗ 𝑆𝐼𝑍𝐸𝑖𝑡 represent the interaction effects between executive compensation and firm size and R&D expenses and firm size respectively. Here 𝑆𝐼𝑍𝐸𝑖𝑡 is the moderating variable. 4. Empirical Results In this chapter, I am presenting the results for the relations that I examine, based on statistical tests. In the beginning, I will analyze the descriptive statistics and the Pearson correlation matrices, while in the end I will present the results of my regression analysis, followed by the acceptance or rejection of my hypotheses. - 26 - The Impact of Executive Compensation and R&D Expenses on Firm Performance: A Comparison between Manufacturing and Services Companies in the United States 4.1 Descriptive Statistics Table 4 reports summary statistics for the key variables for manufacturing and services firms used in this study. Panel A reports mean, median, standard deviation, minimum and maximum values of return on assets, total executive compensation, research and development expenses and sales turnover for manufacturing companies while Panel B for services companies. As it is observed, in both Panels the variables that represent total executive compensation, research and development expenses and sales turnover are substantially skewed to the right with a mean significantly greater than the median. This skewness can be described as asymmetry in a statistical distribution. TABLE 4 - Summary statistics Panel A: Descriptive Statistics for Manufacturing Companies Variables ROA TotalExComp RDExp SaleTurn Mean Median 0.05 0.06 2,625.84 Standard Minimum Maximum 0.66 -8.63 24.09 1,381.38 4,556.13 0.00 377,996.50 407.48 57.80 1,160.48 0.03 12,183.00 9,358.28 1,991.14 29,040.42 0.04 433,526.00 Minimum Maximum Deviation Panel B: Descriptive Statistics for Services Companies Variables ROA TotalExComp RDExp SaleTurn Standard Mean Median 0.02 0.05 0.21 -2.00 0.84 2,699.01 1,262.59 5,778.70 0.00 120,060.70 386.48 62.52 1,224.45 0.10 9,811.00 3,841.24 756.87 13,297.23 1.74 106,916.00 Deviation The examined samples consists of 22,442 manufacturing and 4,828 services firm-year observations from 2000 to 2014 respectively. Data about executive compensation, research and development expenses and sales turnover for the examined period are collected from Compustat Execucomp and Compustat Annual Fundamentals. ROA was constructed using data obtained from Compustat Annual Fundamental database. Total compensation (TDC1 data item on Execucomp) includes salary, bonus, other annual, total value of restricted stock granted, total value of stock options granted (using Black-Scholes), long-term incentive payouts and all other total and referred to the total compensation of the top executives of manufacturing firms. - 27 - The Impact of Executive Compensation and R&D Expenses on Firm Performance: A Comparison between Manufacturing and Services Companies in the United States Following Core and Guay (1999) and Karuna (2007) I will use logarithmic transformation to mitigate this positive skewness. Table 5 present the new summary statistics for ROA and the logarithms of the rest of the key variables. Panel A and Panel B report mean, median, standard deviation, minimum and maximum values of return on assets, the logarithm of total executive compensation, the logarithm of R&D expenses and the logarithm of sales turnover for manufacturing and services companies respectively. It is observed that the mean and the median values are much closer than before, which practically means that now the distribution, is more normal. TABLE 5 - Summary statistics (logarithmic transformation) Panel A: Descriptive Statistics (logarithmic transformation) for Manufacturing Companies Variables Mean Median ROA 0.05 0.06 TotalExComp_log 7.29 RDExp_log SaleTurn_log Standard Minimum Maximum 0.66 -8.63 24.09 7.23 1.07 -6.91 12.84 4.21 4.07 1.86 -3.47 9.41 7.60 7.60 1.81 -3.12 12.98 Deviation Panel B: Descriptive Statistics (logarithmic transformation) for Services Companies Variables Mean Median ROA 0.02 0.05 TotalExComp_log 7.19 RDExp_log SaleTurn_log Standard Minimum Maximum 0.21 -2.00 0.84 7.14 1.23 -6.91 11.70 4.30 4.14 1.74 -2.30 9.19 6.61 6.63 1.63 0.55 11.58 Deviation The examined samples consists of 22,442 manufacturing and 4,828 services firm-year observations from 2000 to 2014 respectively. Data about executive compensation, research and development expenses and sales turnover for the examined period are collected from Compustat Execucomp and Compustat Annual Fundamentals. ROA was constructed using data obtained from Compustat Annual Fundamental database. Total compensation (TDC1 data item on Execucomp) includes salary, bonus, other annual, total value of restricted stock granted, total value of stock options granted (using Black-Scholes), long-term incentive payouts and all other total and referred to the total compensation of the top executives of manufacturing firms. - 28 - The Impact of Executive Compensation and R&D Expenses on Firm Performance: A Comparison between Manufacturing and Services Companies in the United States 4.2 Pearson Correlation Matrix Table 6 presents the Pearson correlation matrix for the main explanatory variables used in the regression analysis. These are total executive compensation (TotalExComp_log), research and development expenses (RDExp_log) and firm size in terms of sales turnover (SaleTurn_log). Panel A reports the results for manufacturing firms, whereas Panel B shows he results for services companies. In both Panels, there are high correlations among all explanatory variables. More specifically, for the manufacturing firms the correlation between TotalExComp_log and RDExp_log is 0.58 and for the services companies the same correlation is 0.48. The fact that the coefficient for manufacturing firms is greater than the one for services companies denotes that this impact is a bit larger in companies of the manufacture sector. Continuously, the positive and significant coefficients between TotalExComp_log and SaleTurn_log for both manufacturing (0.61) and services (0.50) companies demonstrate that larger firms have the economic capacity to pay more their executives. Finally, high correlations are documented also between RDExp_log and SaleTurn_log for both manufacturing (0.70) and services (0.82) companies. The positive and significant coefficients show that larger firms have greater economic capacity to invest in research and development. TABLE 6 - Pearson Correlation Matrices Panel A: Manufacturing Companies TotalExComp_log RDExp_log SaleTurn_log TotalExComp_log 1.00 RDExp_log 0.58*** 1.00 SaleTurn_log 0.61*** 0.70*** 1.00 RDExp_log SaleTurn_log Panel B: Services Companies TotalExComp_log TotalExComp_log) 1.00 RDExp_log 0.48*** 1.00 SaleTurn_log 0.50*** 0.82*** Note: *,**,*** indicate significance at the 10%, 5% and 1% level respectively. - 29 - 1.00 The Impact of Executive Compensation and R&D Expenses on Firm Performance: A Comparison between Manufacturing and Services Companies in the United States 4.3 Main Findings This study focuses on determining whether executive compensation and research and development expenses affect differently manufacturing and services companies in the United States. Table 7 reports the results of the regression analysis based on a log-log Ordinary Least Squares (OLS) model. In general the results show that executive compensation and R&D expenses affect firms’ performance. To begin with, in manufacturing firms-sample the R-sq (R square) shows that 0.2% of the variance of the response variable ROA is explained by this regression model. The coefficient on TotalExComp_log is positive and significant (5% level) in this regression. Hence, I have enough evidence to accept the alternative hypothesis H1a1: Executives’ compensation has a significant positive association with the performance of a manufacturing enterprise in the United States. Particularly, when TotalExComp_log increases the level of agreement with the statement that I am using, ROA also increases. There is also a numerical interpretation for this; that is, for an increase in the total compensation of executives by one unit there is on average an increase in the value of the variable ROA of 0.0129 units. Next, the coefficient on RDExp_log is significant but negative and positive when firm performance is measured in terms of return on assets (ROA). This positive and significant coefficient means that an increase in R&D expenses by one unit will lead to an increase in the value of ROA by 0.0162 units. Based on these, I have enough evidence to accept the alternative hypothesis H1a2: Research and development expenses have a significant positive association with the performance of a manufacturing enterprise in the United States. Furthermore, in services firms-sample the R-sq (R square) shows that 5.9% of the variance of the response variable ROA is explained by this regression model. In this sample the coefficient on TotalExComp_log is positive but not significant. Consequently, I do not have enough evidence to accept the alternative hypothesis H1b1: Executives’ compensation has a significant positive association with the performance of a service company in the United States. This might be explained by the fact that some companies belonging to the services sector, such as banks and other financial institutions, are regulated to a greater extent than manufacturing companies. Hence, the pay-performance sensitivity is expected to be much lower. - 30 - The Impact of Executive Compensation and R&D Expenses on Firm Performance: A Comparison between Manufacturing and Services Companies in the United States Moreover, the coefficients of RDExp_log in the regression, is significant (1% level) but negative. The negative coefficient means that as RDExp_log increases the level of agreement with the statement that I am using, ROA decreases. The numerical interpretation for this is that for an increase in R&D investments by one unit there is on average a decrease in the value of the variable ROA of 0.0165 units. As a result, I cannot accept the alternative hypothesis H1b2: Research and development expenses have a significant association with the performance of a service company in the United States., despite the fact the coefficient is significant. Finally, based on all the aforementioned about executive compensation I have enough evidence to accept H2: The significant positive association of executives’ compensation with firm performance is bigger in manufacturing than in services companies in the United States. As far as the second independent variable is concerned, the association between research and development expenses and firm performance is also bigger in manufacturing than in services companies. Based on these, I have enough evidence to accept H3: The significant positive association of research and development expenses with firm performance is bigger in manufacturing than in services companies in the United States. TABLE 7 - Regression Analysis Manufacturing Firms Services Firms ROA ROA -0.0263*** 0.0439*** (-7.12) (13.59) 0.0162*** -0.0165*** (4.67) (-5.50) 0.0129** 0.0002 (2.39) (0.07) 0.0880*** -0.203*** (2.71) (-10.84) N 22,442 4,828 R-sq 0.002 0.059 SaleTurn_log RDExp_log TotalExComp_log _cons Note: *,**,*** indicate significance at the 10%, 5% and 1% level respectively. - 31 - The Impact of Executive Compensation and R&D Expenses on Firm Performance: A Comparison between Manufacturing and Services Companies in the United States 4.4 Interaction Effects In this chapter, I will present the results of the regression analysis focusing on the interaction effects between executive compensation and firm size and R&D expenses and firm size. Table 8 below shows the interaction effect between executive compensation and firm size. The positive and significant (1% level) coefficient of the interaction effect depicted through the variable ExComp_SaleTurn for manufacturing companies stress that H4a: The impact of executives’ compensation on the performance of a manufacturing company in the United States should be greater in larger firms is accepted. This means that larger firms have the economic capacity to pay more their executives. The same coefficient for services companies in not significant, hence I have to reject H4b: The impact of executives’ compensation on the performance of a service company in the United States should be greater in larger firms. TABLE 8 – Interaction Effect between Executive Compensation and Firm Size Manufacturing Firms Services Firms ROA ROA 0.0143*** -0.0166*** (4.10) (-5.52) -0.1142*** -0.0046 (-6.76) (-0.46) -0.1338*** 0.0392*** (-9.54) (3.89) 0.0154*** 0.0007 (7.95) (0.50) 0.9701*** -0.1689** (8.39) (-2.39) N 22,441 4,282 R-sq 0.005 0.060 RDExp_log TotalExComp_log SaleTurn_log ExComp_SaleTurn _cons Note: *,**,*** indicate significance at the 10%, 5% and 1% level respectively. Table 9 shows the interaction effect between R&D expenses and firm size. The positive and significant coefficients of the interaction - 32 - effect depicted through the variable The Impact of Executive Compensation and R&D Expenses on Firm Performance: A Comparison between Manufacturing and Services Companies in the United States RDExp_SaleTurn for both manufacturing (0.0632) and services (0.0032) companies stress that H5a and H5b (The impact of research and development expenses on the performance of a manufacturing or service company respectively in the United States should be greater in larger firms) stand. TABLE 9 – Interaction Effect between R&D expenses and Firm Size Manufacturing Firms Services Firms ROA ROA 0.0134** 0.0000 (2.47) (0.01) -0.0364*** -0.0399*** (-3.54) (-6.42) -0.0515*** 0.0293*** (-8.70) (6.24) 0.0632*** 0.0032*** (5.45) (4.30) 0.2807*** -0.1041*** (5.85) (-3.52) N 22,442 4,282 R-sq 0.004 0.063 TotalExComp_log RDExp_log SaleTurn_log RDExp_SaleTurn _cons Note: *,**,*** indicate significance at the 10%, 5% and 1% level respectively. The interaction results are quiet important for financial managers who are responsible for the financial health of a company. Financial managers develop plans and strategies that set the long-term financial goals of their companies. More specifically, the interaction effect between executive compensation and firm size (for manufacturing companies) and the interaction effect between R&D expenses and firm size (for both manufacturing and services companies) are positive. Hence, these results provide financial managers with the opportunity to build proper compensation and innovation (R&D) systems that will maximize firm performance according to each company’s size. - 33 - The Impact of Executive Compensation and R&D Expenses on Firm Performance: A Comparison between Manufacturing and Services Companies in the United States 5. Conclusion This study, based on empirically data, tries to answer the following question: RQ: Does executive compensation and R&D expenses have a stronger impact on the output of services firms than on manufacturing companies in the United States? With regard to the theory, this study shows that the relation between executive compensation and the performance of manufacturing firms is positive, whereas the relation between executive compensation and the performance of services companies does not exist at all. To begin with, prior and more recent empirical studies provide contradictory results on the relationship between executive compensation and firm performance. However, the vast majority of the already existing literature stresses the positive impact of executive compensation on firm performance. Researchers like Chaubey and Kulkarni (1988), Zajac (1990) and Wallsten (1999) pointed out the strong, unbreakable link between these two variables. Furthermore, Mehran (1995), Hubbard and Palia (1995) and Canarella and Gasparyan (2008) found that the aforementioned relationship applies for both manufacturing and services companies. These studies lead me to hypothesize that the more executives are paid the better firm performance will be. The empirical results support this hypothesis for manufacturing companies but not for services companies for which this association is neither negative nor positive. In this part it should be interesting to compare my results with some contradictory results of the prior literature. More specifically, there are researchers like Firth et al. (2006), Doucouliagos et al. (2007) and Zhou et al. (2011) that found no association between payments and performance. The basic reason that my results differ from theirs is the different firmsamples that we used. As far as the manufacturing-firm-sample is concerned, Doucouliagos et al. (2007) and Zhou et al. (2011) were focused on banks which are characterized by a higher degree of regulation, whereas Firth et al. (2006) used state owned companies. On the other hand, in service-firm-sample there is not an association between executive payments and firm performance. This could be possibly because this sample contains also banks and other financial services companies. Furthermore, this study finds that the relation between R&D expenses and the performance of manufacturing firms is positive, while the same relation is negative for services companies. - 34 - The Impact of Executive Compensation and R&D Expenses on Firm Performance: A Comparison between Manufacturing and Services Companies in the United States After a careful reviewing of the literature about the impact of R&D expenses on firm performance, both prior and more recent literature show the positive impact that research and development expense have on firm performance. Among the supporters of this positive association are Hirschey and Weygandt (1985), Lev and Sougiannis (1999) and Cooper et al. (2008), who are nevertheless emphasized on the future and not the present value of R&D expenses on firm performance. In addition, according to Mansfield and Lee (1996) and Ehie and Olibe (2010) both manufacturing and services companies use research and development expenses to develop their products and services, hence their future returns. These studies lead me to hypothesize that the more R&D expenses a company use the better firm performance will be. The empirical results support this hypothesis for manufacturing companies but not for services companies for which this association is negative. Based on the results, executive compensation positively affects the performance of manufacturing companies but it does not have an impact at all on the performance of services companies. Additionally, R&D expenses have a positive impact on the performance of manufacturing companies, but a negative one on the performance of services companies. According to this research’s results, it is strongly supported that executive compensation affect more the performance of manufacturing firms, as well as do R&D. Moreover, the findings show that the impact of executive compensation on performance is going to be larger in larger companies belonging in the manufacturing sector, while it seems that this association does not apply for the services firms. Finally, the association between R&D expenses and firm size is positive (for both manufacturing and services companies). The results of this study are important to the large proportion of the American public that owns shares in American manufacturing firms, as well as to foreign investors. Specifically, in manufacturing companies the positive association between executive compensation and firm performance on the one hand and R&D expenses and firm performance on the other hand show that there is a chance for better management and higher profits. This indicates that these associations implicate that policy-makers in manufacturing companies could create compensation formulas to induce executives to attribute the best of their capabilities. Moreover, they could create proper systems that would release funds for research and development in order to obtain larger part in the economy. Unfortunately, for services companies there is not an association between executive payments and firm performance. - 35 - The Impact of Executive Compensation and R&D Expenses on Firm Performance: A Comparison between Manufacturing and Services Companies in the United States Possibly, because of the greater degree of regulation of the financial firms that belong to the greater services-firms sample. 5.1 Limitations and Future Research There are two limitations to this study. First, the classification of companies in only two major industries: the manufacturing and the services companies. The problem here is that companies that belong to one of the two categories may differ among them a lot. For example, financial services companies are characterized from a higher degree of regulation, which lead to a lower pay-performance sensitivity. This could alter significantly the results of this study for other companies that belong also to the broader services industry. Another limitation is that this study examines the impact of executive compensation and R&D expenses on performance for a period of time. Hence the impact may not be quiet visible. By this I mean that the examined impact may be more obvious if there was a comparison to the same impact in another period of time. These limitations may be overcome with further research in the future. More specifically, it would be beneficiary to examine the same impact in industries with different classification. For example, future research may focus on the impact of executive compensation on automotive industry versus financial services industry. Moreover, a comparison of the examined impact during different decades may reveal how much this impact increased. 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Asian Social Science, 7 (8), 65-80. - 44 - The Impact of Executive Compensation and R&D Expenses on Firm Performance: A Comparison between Manufacturing and Services Companies in the United States Appendix TABLE 1 - Definition and Measurement of Variables Variable Name Definition Category ROA Return on Assets Dependent Variable Total Executive Compensation Research and development expenses Independent Variable (control variable) TotalExComp_log RDExp_log Independent Variable (control variable) SaleTurn_log Sales Turnover Control Variable (Moderator Variable) ExComp_SaleTurn Total Executive Compensation * Sales Turnover Interaction Effect RDExp_SaleTurn R&D expenses * Sales Turnover Interaction Effect Measurement The return on assets of each firm The natural logarithm of total executive compensation The natural logarithm of research and development expenses of each firm The natural logarithm of sales turnover of each firm The interaction effect between executive payments and firm size The interaction effect between R&D expenses and firm size TABLE 2 SIC codes of manufacturing companies and their description 2000 Food and Kindred Products 2011 Meat Packing Plants 2013 Sausages & Other Prepared Meat Products 2015 Poultry Slaughtering and Processing 2020 Dairy Products 2024 Ice Cream & Frozen Desserts 2030 Canned, Frozen & Preserved Fruit, Veg & Food Specialties 2033 Canned, Fruits, Veg, Preserves, Jams & Jellies 2040 Grain Mill Products 2050 Bakery Products 2052 Cookies & Crackers 2060 Sugar & Confectionery Products 2070 Fats & Oils 2080 Beverages 2082 Malt Beverages - 45 - The Impact of Executive Compensation and R&D Expenses on Firm Performance: A Comparison between Manufacturing and Services Companies in the United States 2086 Bottled & Canned Soft Drinks & Carbonated Waters 2090 Miscellaneous Food Preparations & Kindred Products 2092 Prepared Fresh or Frozen Fish & Seafood 2100 Tobacco Products 2111 Cigarettes 2200 Textile Mill Products 2211 Broadwoven Fabric Mills, Cotton 2221 Broadwoven Fabric Mills, Man Made Fiber & Silk 2250 Knitting Mills 2253 Knit Outerwear Mills 2273 Carpets & Rugs 2300 Apparel & Other Finished Prods of Fabrics & Similar Matl 2320 Men's & Boys' Furnishings, Work Clothing, & Allied Garments 2330 Women's, Misses', and Juniors Outerwear 2340 Women's, Misses', Children's & Infant's Undergarments 2390 Miscellaneous Fabricated Textile Products 2400 Lumber & Wood Products (No Furniture) 2421 Sawmills & Planing Mills, General 2430 Millwood, Veneer, Plywood, & Structural Wood Members 2451 Mobile Homes 2452 Prefabricated Wood Bldgs & Components 2510 Household Furniture 2511 Wood Household Furniture, (No Upholstered) 2520 Office Furniture 2522 Office Furniture (No Wood) 2531 Public Bldg & Related Furniture 2540 Partitions, Shelvg, Lockers, & office & Store Fixtures 2590 Miscellaneous Furniture & Fixtures 2600 Papers & Allied Products 2611 Pulp Mills - 46 - The Impact of Executive Compensation and R&D Expenses on Firm Performance: A Comparison between Manufacturing and Services Companies in the United States 2621 Paper Mills 2631 Paperboard Mills 2650 Paperboard Containers & Boxes 2670 Converted Paper & Paperboard Prods (No Containers/Boxes) 2673 Plastics, Foil & Coated Paper Bags 2711 Newspapers: Publishing or Publishing & Printing 2721 Periodicals: Publishing or Publishing & Printing 2731 Books: Publishing or Publishing & Printing 2732 Book Printing 2741 Miscellaneous Publishing 2750 Commercial Printing 2761 Manifold Business Forms 2771 Greeting Cards 2780 Blankbooks, Looseleaf Binders & Bookbinding & Related Work 2790 Service Industries For The Printing Trade 2800 Chemicals & Allied Products 2810 Industrial Inorganic Chemicals 2820 Plastic Material, Synth Resin/Rubber, Cellulos (No Glass) 2821 Plastic Materials, Synth Resins & Nonvulcan Elastomers 2833 Medicinal Chemicals & Botanical Products 2834 Pharmaceutical Preparations 2835 In Vitro & In Vivo Diagnostic Substances 2836 Biological Products, (No Diagnostic Substances) 2840 Soap, Detergents, Cleaning Preparations, Perfumes, Cosmetics 2842 Specialty Cleaning, Polishing and Sanitation Preparations 2844 Perfumes, Cosmetics & Other Toilet Preparations 2851 Paints, Varnishes, Lacquers, Enamels & Allied Prods 2860 Industrial Organic Chemicals 2870 Agricultural Chemicals 2890 Miscellaneous Chemical Products - 47 - The Impact of Executive Compensation and R&D Expenses on Firm Performance: A Comparison between Manufacturing and Services Companies in the United States 2891 Adhesives & Sealants 2911 Petroleum Refining 2950 Asphalt Paving & Roofing Materials 2990 Miscellaneous Products of Petroleum & Coal 3011 Tires & Inner Tubes 3021 Rubber & Plastics Footwear 3050 Gaskets, Packg & Sealg Devices & Rubber & Plastics Hose 3060 Fabricated Rubber Products, NEC 3080 Miscellaneous Plastics Products 3081 Unsupported Plastics Film & Sheet 3086 Plastics Foam Products 3089 Plastics Products, NEC 3100 Leather & Leather Products 3140 Footwear, (No Rubber) 3211 Flat Glass 3220 Glass & Glassware, Pressed or Blown 3221 Glass Containers 3231 Glass Products, Made of Purchased Glass 3241 Cement, Hydraulic 3250 Structural Clay Products 3260 Pottery & Related Products 3270 Concrete, Gypsum & Plaster Products 3272 Concrete Products, Except Block & Brick 3281 Cut Stone & Stone Products 3290 Abrasive, Asbestos & Misc Nonmetallic Mineral Prods 3310 Steel Works, Blast Furnaces & Rolling & Finishing Mills 3312 Steel Works, Blast Furnaces & Rolling Mills (Coke Ovens) 3317 Steel Pipe & Tubes 3320 Iron & Steel Foundries 3330 Primary Smelting & Refining of Nonferrous Metals - 48 - The Impact of Executive Compensation and R&D Expenses on Firm Performance: A Comparison between Manufacturing and Services Companies in the United States 3334 Primary Production of Aluminum 3341 Secondary Smelting & Refining of Nonferrous Metals 3350 Rolling Drawing & Extruding of Nonferrous Metals 3357 Drawing & Insulating of Nonferrous Wire 3360 Nonferrous Foundries (Castings) 3390 Miscellaneous Primary Metal Products 3411 Metal Cans 3412 Metal Shipping Barrels, Drums, Kegs & Pails 3420 Cutlery, Handtools & General Hardware 3430 Heating Equip, Except Elec & Warm Air; & Plumbing Fixtures 3433 Heating Equipment, Except Electric & Warm Air Furnaces 3440 Fabricated Structural Metal Products 3442 Metal Doors, Sash, Frames, Moldings & Trim 3443 Fabricated Plate Work (Boiler Shops) 3444 Sheet Metal Work 3448 Prefabricated Metal Buildings & Components 3451 Screw Machine Products 3452 Bolts, Nuts, Screws, Rivets & Washers 3460 Metal Forgings & Stampings 3470 Coating, Engraving & Allied Services 3480 Ordnance & Accessories, (No Vehicles/Guided Missiles) 3490 Miscellaneous Fabricated Metal Products 3510 Engines & Turbines 3523 Farm Machinery & Equipment 3524 Lawn & Garden Tractors & Home Lawn & Gardens Equip 3530 Construction, Mining & Materials Handling Machinery & Equip 3531 Construction Machinery & Equip 3532 Mining Machinery & Equip (No Oil & Gas Field Mach & Equip) 3533 Oil & Gas Field Machinery & Equipment 3537 Industrial Trucks, Tractors, Trailers & Stackers - 49 - The Impact of Executive Compensation and R&D Expenses on Firm Performance: A Comparison between Manufacturing and Services Companies in the United States 3540 Metalworkg Machinery & Equipment 3541 Machine Tools, Metal Cutting Types 3550 Special Industry Machinery (No Metalworking Machinery) 3555 Printing Trades Machinery & Equipment 3559 Special Industry Machinery, NEC 3560 General Industrial Machinery & Equipment 3561 Pumps & Pumping Equipment 3562 Ball & Roller Bearings 3564 Industrial & Commercial Fans & Blowers & Air Purifying Equip 3567 Industrial Process Furnaces & Ovens 3569 General Industrial Machinery & Equipment, NEC 3570 Computer & office Equipment 3571 Electronic Computers 3572 Computer Storage Devices 3575 Computer Terminals 3576 Computer Communications Equipment 3577 Computer Peripheral Equipment, NEC 3578 Calculating & Accounting Machines (No Electronic Computers) 3579 Office Machines, NEC 3580 Refrigeration & Service Industry Machinery 3585 Air-Cond & Warm Air Heatg Equip & Comm & Indl Refrig Equip 3590 Misc Industrial & Commercial Machinery & Equipment 3600 Electronic & Other Electrical Equipment (No Computer Equip) 3612 Power, Distribution & Specialty Transformers 3613 Switchgear & Switchboard Apparatus 3620 Electrical Industrial Apparatus 3621 Motors & Generators 3630 Household Appliances 3634 Electric Housewares & Fans 3640 Electric Lighting & Wiring Equipment - 50 - The Impact of Executive Compensation and R&D Expenses on Firm Performance: A Comparison between Manufacturing and Services Companies in the United States 3651 Household Audio & Video Equipment 3652 Phonograph Records & Prerecorded Audio Tapes & Disks 3661 Telephone & Telegraph Apparatus 3663 Radio & TV Broadcasting & Communications Equipment 3669 Communications Equipment, NEC 3670 Electronic Components & Accessories 3672 Printed Circuit Boards 3674 Semiconductors & Related Devices 3677 Electronic Coils, Transformers & Other Inductors 3678 Electronic Connectors 3679 Electronic Components, NEC 3690 Miscellaneous Electrical Machinery, Equipment & Supplies 3695 Magnetic & Optical Recording Media 3711 Motor Vehicles & Passenger Car Bodies 3713 Truck & Bus Bodies 3714 Motor Vehicle Parts & Accessories 3715 Truck Trailers 3716 Motor Homes 3720 Aircraft & Parts 3721 Aircraft 3724 Aircraft Engines & Engine Parts 3728 Aircraft Parts & Auxiliary Equipment, NEC 3730 Ship & Boat Building & Repairing 3743 Railroad Equipment 3751 Motorcycles, Bicycles & Parts 3760 Guided Missiles & Space Vehicles & Parts 3790 Miscellaneous Transportation Equipment 3812 Search, Detection, Navigation, Guidance, Aeronautical Sys 3821 Laboratory Apparatus & Furniture 3822 Auto Controls For Regulating Residential & Comml Environments - 51 - The Impact of Executive Compensation and R&D Expenses on Firm Performance: A Comparison between Manufacturing and Services Companies in the United States 3823 Industrial Instruments For Measurement, Display, and Control 3824 Totalizing Fluid Meters & Counting Devices 3825 Instruments For Meas & Testing of Electricity & Elec Signals 3826 Laboratory Analytical Instruments 3827 Optical Instruments & Lenses 3829 Measuring & Controlling Devices, NEC 3841 Surgical & Medical Instruments & Apparatus 3842 Orthopedic, Prosthetic & Surgical Appliances & Supplies 3843 Dental Equipment & Supplies 3844 X-Ray Apparatus & Tubes & Related Irradiation Apparatus 3845 Electromedical & Electrotherapeutic Apparatus 3851 Ophthalmic Goods 3861 Photographic Equipment & Supplies 3873 Watches, Clocks, Clockwork Operated Devices/Parts 3910 Jewelry, Silverware & Plated Ware 3911 Jewelry, Precious Metal 3931 Musical Instruments 3942 Dolls & Stuffed Toys 3944 Games, Toys & Children's Vehicles (No Dolls & Bicycles) 3949 Sporting & Athletic Goods, NEC 3950 Pens, Pencils & Other Artists' Materials 3960 Costume Jewelry & Novelties 3990 Miscellaneous Manufacturing Industries TABLE 3 SIC codes of services firms and their description 6012 Pay Day Lenders 6021 National Commercial Banks 6022 State Commercial Banks 6029 Commercial Banks, NEC - 52 - The Impact of Executive Compensation and R&D Expenses on Firm Performance: A Comparison between Manufacturing and Services Companies in the United States 6035 Savings Institution, Federally Chartered 6036 Savings Institutions, Not Federally Chartered 6099 Functions Related To Depository Banking, NEC 6111 Federal & Federally Sponsored Credit Agencies 6141 Personal Credit Institutions 6153 Short-Term Business Credit Institutions 6159 Miscellaneous Business Credit Institution 6162 Mortgage Bankers & Loan Correspondents 6163 Loan Brokers 6172 Finance Lessors 6189 Asset-Backed Securities 6199 Finance Services 6200 Security & Commodity Brokers, Dealers, Exchanges & Services 6211 Security Brokers, Dealers & Flotation Companies 6221 Commodity Contracts Brokers & Dealers 6282 Investment Advice 6311 Life Insurance 6321 Accident & Health Insurance 6324 Hospital & Medical Service Plans 6331 Fire, Marine & Casualty Insurance 6351 Surety Insurance 6361 Title Insurance 6399 Insurance Carriers, NEC 6411 Insurance Agents, Brokers & Service 6500 Real Estate 6510 Real Estate Operators (No Developers) & Lessors 6512 Operators of Nonresidential Buildings 6513 Operators of Apartment Buildings 6519 Lessors of Real Property, NEC 6531 Real Estate Agents & Managers (For Others) - 53 - The Impact of Executive Compensation and R&D Expenses on Firm Performance: A Comparison between Manufacturing and Services Companies in the United States 6532 Real Estate Dealers (For Their Own Account) 6552 Land Subdividers & Developers (No Cemeteries) 6770 Blank Checks 6792 Oil Royalty Traders 6794 Patent Owners & Lessors 6795 Mineral Royalty Traders 6798 Real Estate Investment Trusts 6799 Investors, NEC 7000 Hotels, Rooming Houses, Camps & Other Lodging Places 7011 Hotels & Motels 7200 Services-Personal Services 7310 Services-Advertising 7311 Services-Advertising Agencies 7320 Services-Consumer Credit Reporting, Collection Agencies 7330 Services-Mailing, Reproduction, Commercial Art & Photography 7331 Services-Direct Mail Advertising Services 7334 Services-Photocopying and Duplicating Services 7340 Services-To Dwellings & Other Buildings 7350 Services-Miscellaneous Equipment Rental & Leasing 7359 Services-Equipment Rental & Leasing, NEC 7361 Services-Employment Agencies 7363 Services-Help Supply Services 7370 Services-Computer Programming, Data Processing, Etc. 7371 Services-Computer Programming Services 7372 Services-Prepackaged Software 7373 Services-Computer Integrated Systems Design 7374 Services-Computer Processing & Data Preparation 7377 Services-Computer Rental & Leasing 7380 Services-Miscellaneous Business Services 7381 Services-Detective, Guard & Armored Car Services - 54 - The Impact of Executive Compensation and R&D Expenses on Firm Performance: A Comparison between Manufacturing and Services Companies in the United States 7384 Services-Photofinishing Laboratories 7385 Services-Telephone Interconnect Systems 7389 Services-Business Services, NEC 7500 Services-Automotive Repair, Services & Parking 7510 Services-Auto Rental & Leasing (No Drivers) 7600 Services-Miscellaneous Repair Services 7812 Services-Motion Picture & Video Tape Production 7819 Services-Allied To Motion Picture Production 7822 Services-Motion Picture & Video Tape Distribution 7829 Services-Allied To Motion Picture Distribution 7830 Services-Motion Picture Theaters 7841 Services-Video Tape Rental 7900 Services-Amusement & Recreation Services 7948 Services-Racing, Including Track Operation 7990 Services-Miscellaneous Amusement & Recreation 7994 Services-Video Game Arcades 7995 Services-Gambling Transactions 7996 Services-Amusement Parks 7997 Services-Membership Sports & Recreation Clubs 8000 Services-Health Services 8011 Services-Offices & Clinics of Doctors of Medicine 8050 Services-Nursing & Personal Care Facilities 8051 Services-Skilled Nursing Care Facilities 8060 Services-Hospitals 8062 Services-General Medical & Surgical Hospitals, NEC 8071 Services-Medical Laboratories 8082 Services-Home Health Care Services 8090 Services-Misc Health & Allied Services, NEC 8093 Services-Specialty Outpatient Facilities, NEC 8111 Services-Legal Services - 55 - The Impact of Executive Compensation and R&D Expenses on Firm Performance: A Comparison between Manufacturing and Services Companies in the United States 8200 Services-Educational Services 8300 Services-Social Services 8351 Services-Child Day Care Services 8600 Services-Membership organizations 8700 Services-Engineering, Accounting, Research, Management 8711 Services-Engineering Services 8731 Services-Commercial Physical & Biological Research 8734 Services-Testing Laboratories 8741 Services-Management Services 8742 Services-Management Consulting Services 8744 Services-Facilities Support Management Services 8748 Business Consulting Services, Not Elsewhere Classified 8880 American Depositary Receipts 8888 Foreign Governments 8900 Services-Services, NEC - 56 -