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A STUDY OF THE RELATIONSHIP BETWEEN CEO COMPENSATION AND FIRM PERFORMANCE IN THE U.S. AIRLINE INDUSTRY: 2002-2006 By Trudy Dawkins Morlino RICHARD MURPHY, D.B.A., Faculty Mentor and Chair THOMAS FORD, Ed.D., Committee Member KENNETH GRANBERRY, D.I.B.A., Committee Member Kurt Linberg, Ph.D., Dean, School of Business & Technology A Dissertation Presented in Partial Fulfillment Of the Requirements for the Degree Doctor of Philosophy Capella University September 2008 3324731 3324731 2008 Copyright 2008 by All rights reserved © Trudy Morlino, 2008 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. iii 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. iv 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! v 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 vi 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 vii . structure of the industry causes instability. Hecker (2005) argues that the inherent instability of the airline industry can be traced to the structure of the industry. costs in the airline industry are generally composed of flying operations, aircraft and traffic service, maintenance, general and administrative costs, and