The problem of how best to compensate executives is a classic application of the principal-agent theory. While the literature on pay-performance has been largely focussed on the Anglo-Saxon economies, limited research has been carried out in the context of emerging markets. In the Indian context, studies focussing on the managerial labour market and executive compensation have been a recent phenomenon.

We examine the relationship between pay and performance from the year 2002 to 2012 for a sample of Indian listed firms. We employ the system- generalised methods of moments (GMM) estimator to account for the potential endogeneity (between pay and performance) problem in examining the pay-performance relationship among the sample firms. Thus, to the best of our knowledge, ours is an attempt for the first time to comprehensively examine the pay-performance relationship among Indian firms, using the wider firm level dataset.

We report significant persistence in executive compensation among the sample firms. The persistence in the executive compensation exists even among the sub-samples of firms, classified based on size and ownership. Findings also suggest the existence of significant pay-performance relationship among the sample firms. However, when performance is measured using market based measures, we do not find pay-performance relationship among the sample firms. It may be argued that sample firms determine their executive compensation based on the accounting based measures of firm performance rather than market based measures. Further, we report the absence of pay-performance relationship among the business group affiliated firms, whereas their stand-alone counterparts report significant pay-performance relationship. Such an observation casts doubts over the performance based executive compensation practices of Indian business group affiliated firms. We also find that the pay-performance relationship is absent among the small sample firms, but the relationship is significant among the larger sample firms.