Is there an inverse U-shaped relationship between pay and performance?

Given the increasing concerns about the escalation in executive compensation, this study aims to provide new insights into the link between executive pay and firm performance by empirically testing for an inverse U-shaped relationship. For this purpose, we re-examine the relation using a nonlinear model. Our results show a significant inverse U-shaped relationship between executive pay and firm performance. The finding provides support for both optimal contracting and managerial power theories with the former dominating at low level of firm performance and the latter dominating at high level of firm performance.