A STUDY OF THE RELATIONSHIP BETWEEN CEO COMPENSATION AND FIRM PERFORMANCE IN THE US AIRLINE INDUSTRY 2002 2006

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Abstract
This study addressed the relationship between CEO compensation and firm
performance in the U.S. domestic passenger airline industry, a low managerial
discretion industry. To answer the question, is there a relationship between CEO
compensation (salary plus bonus) and the independent variables, return on assets, return
on equity and the debt-to-asset ratio, this study applied nonparametric statistics to a
sample of publicly traded U.S. airlines for a five-year period, 2002-2006. Data for the
study period relied exclusively on secondary data compiled by the Securities and
Exchange EDGAR database and publicly available annual reports. The sample for this
study consisted of 15 years of CEO compensation and firm performance data for three
of the historically dominant U.S. scheduled domestic passenger airlines, SIC 4512,
NAICS 48111. This study was limited to publicly traded U.S. ‘legacy’ airlines that
operated primarily as a scheduled air passenger service where the CEO of the firm held
the position for three consecutive years during the study period. Tests were conducted
using Pearson product moment correlation and Spearman’s rank correlation. However,
for this study, all hypotheses were tested using Spearman’s correlation coefficient.
Spearman’s rho (p) nonparametric statistic was chosen because three major assumptions
of the Pearson’s parametric correlation (r) were violated. The results indicated that
there is a statistically significant negative relationship between the rank ordered CEO
compensation (salary plus bonus) and rank ordered return on assets (ROA). The study
found no statistically significant relationship between rank ordered CEO compensation
(salary plus bonus) and rank ordered return on equity (ROE) or between the rank
ordered CEO compensation (salary plus bonus) and the rank ordered debt-to-asset ratio.
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Dedication
This work is dedicated to my daughter, Rebecca, who gave me the courage to
undertake this project. Without her love, understanding and support this work would
not have been possible. Her encouragement, patience, and belief in me throughout this
journey allowed me to reach my goal.
I would also like to dedicate this work to my husband, Buster, my sister, Cassie,
and my brother, Chuck, for their ability to offer constructive criticism when needed as
well as for their financial support throughout this process.
To my parents, Becky and Harold Dawkins, who are looking down on me from
above, thank you for giving me the foundation I needed to even consider such an
undertaking as this.

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Acknowledgements
First and foremost, I am extremely grateful to my mentor, Dr. Richard Murphy,
for his support and guidance. He managed to keep me focused and helped me to see the
light at the end of this very, long tunnel. Without his advice, wisdom, and humor, this
project would have never been completed. The insightful suggestions from my
committee members, Dr. Kenneth Granberry and Dr. Tomas Ford, helped to shape the
final product.
I am also grateful to Steve Creech who helped me with the statistical tests and
analysis. His knowledge and support guided me through many storms.
Finally, a debt of gratitude goes to my colleagues who laughed with me and
cried with me throughout this journey, thank you!
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Table of Contents
Acknowledgments iv
List of Tables viii
List of Figures ix
CHAPTER 1. INTRODUCTION 1
Introduction 1
History of the U.S. Airline Industry 2
Industry Structure 4
Background of the Study 7
Statement of the Problem 9
Purpose of the Study 14
Research Questions 16
Hypotheses 17
Significance of the Study 18
Definitions and Key Terms 19
Assumptions and Limitations 22
Organization of the Study 21
CHAPTER 2. LITERATURE REVIEW 22
Introduction 23
Theoretical Determinants of CEO Compensation 33
Stock Options as Part of Executive Compensation 45
Who Controls a Corporation? 48
Is There a Diminishing Marginal Utility to Money? 53
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CHAPTER 3. METHODOLOGY 53
Introduction 53
The Research Process 53
Research Design 61
Research Questions 62
Research Hypotheses 62
Instrument 63
Validity and Reliability 63
Population and Sampling 64
Firm Specific Characteristics 67
Statistical Procedures 70
Research Variables 72
CHAPTER 4. RESULTS AND ANALYSIS 73
Introduction 73
Research Questions 73
Hypotheses 74
Variables 75
Analytical Techniques 75
Descriptive Statistics 77
Test of Hypotheses One 75
Test of Hypotheses Two 86
Test of Hypotheses Three 85
CHAPTER 5. DISCUSSION, IMPLICATIONS, AND RECOMMENDATIONS 100
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Introduction 100
Limitations of the Study 103
Suggestions for Future Research 103
REFERENCES 105
viii
List of Tables
Table 1. Revenue Passenger Miles (RPM) and Market Share Percentage 17
Table 2. CEO Compensation Factors and Correlated Studies 55
Table 3. Total Operating Revenue 65
Table 4. Spearman’s rho for Rank Ordered Study Variables With Outliers 77
Table 5. Descriptive Statistics for Study Airlines 78
Table 6. Rank Ordered CEO Compensation and Rank Ordered Return on
Assets (ROA) With Outliers 83
Table 7. Rank Ordered CEO Compensation and Rank Ordered Return on
Assets (ROA) With Out Outliers 83
Table 8. Rank Ordered CEO Compensation and Rank Ordered Return on
Equity (ROE) 90
Table 9. Rank Ordered CEO Compensation and Rank Ordered
Debt-to-Asset Ratio 93
Table 10. Distribution Attributes of Study Variables 94
Table 11. Low Discretion Industries 96
Table 12. Summary of Research on CEO Compensation, ROA, and ROE 98
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List of Figures
Figure 1. Histogram of CEO compensation 79
Figure 2. Histogram of return on assets (ROA) 80
Figure 3. Scatter plot of CEO compensation and return on assets (ROA) 81
Figure 4. Scatter plot of rank ordered CEO compensation and rank ordered
return on assets (ROA) 82
Figure 5. Scatter plot of rank ordered CEO compensation and rank ordered
return on assets (ROA) with outlier 84
Figure 6. Scatter plot of rank ordered CEO compensation and rank ordered
return on assets (ROA) without outlier 85
Figure 7. Histogram of return on equity (ROE) 87
Figure 8. Scatter plot of CEO compensation and return on equity (ROE) 88
Figure 9. Scatter plot of rank ordered CEO compensation and rank ordered
return on Equity (ROE) 89
Figure 10. Histogram of debt-to-asset ratio 91
Figure 11. CEO compensation and debt-to-asset ratio 92
Figure 12. Rank ordered CEO compensation and rank ordered
debt-to-asset ratio 93
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CHAPTER 1. INTRODUCTION TO THE STUDY
Introduction
It is generally accepted that the role of the chief executive officer (CEO) has the
greatest influence on the performance of the firm and is considered by many as the most
important role in the management of a corporation. In publicly traded U.S.
corporations, the CEO’s primary responsibility is to carry out the strategic plans and
policies established by the board of directors. As the leader of the firm, the CEO has an
astounding impact on the performance of the firm and many believe this to be the result
of the tremendous growth in executive compensation over the last several decades.
Others have suggested that the growth in executive compensation is not related to firm
performance. For instance, Abowd and Kaplan (1999) argue that firm size may be the
reason for the variability in CEO compensation while firm profitability appears to be an
insignificant factor in executive compensation. Conversely, Deckop (1988) found that
CEO compensation was positively correlated to firm profit as a percentage of sales.
Labor market theory posits that the demand for highly skilled and well-educated
workers remains relatively scarce in the market thus; the rising demand for the skills of
a CEO has shown up in rapidly rising compensation for CEOs (McConnell & Brue,
2005).
In the last several decades, CEO compensation has become a major controversy
among shareholders, in the media and academia, and has experienced pressure in the
legislature and economic arenas. The literature suggests there are many and varied
reasons for the interest in executive compensation in U.S. corporations. However, one
indicator appears to be the most prevalent. In 2005, the average CEO in the United
States earned more in one workday than the average worker earned the entire year
1