This paper utilises the non-parametric frontier approach, data envelopment analysis, to analyse the technical and scale efficiency in Japanese banking using a recent cross-section sample. Efficiency analysis is conducted across individual banks, bank types and bank size groups. Following Berger and Humphrey [Eur. J. Oper. Res. 98 (1997) 175], problem loans are controlled for as an exogenous influence on bank efficiency. Powerful size-efficiency relationships are established with respect to both technical and scale efficiency. Furthermore, the logic of the recent large-scale merger wave in Japan is questioned as the larger (City) banks are generally found to be operating above the minimum efficient scale and to have limited opportunity to gain from eliminating X-inefficiencies. The opposite result is found for the smaller banks. Finally, the results suggest that controlling for the exogenous impact of problem loans is important in Japanese banking, especially for the smaller regional banks.

We develop a model that clarifies how to measure CEO incentive strength and how to reconcile the enormous differences in pay sensitivities between executives in large and small firms. The crucial parameter is shown to be the elasticity of CEO productivity with respect to firm size. We find that CEO marginal products rise significantly with firm size (confirming Rosen's conjecture that CEOs of large firms have a "chain letter" effect on firm performance), and overall CEO incentives are roughly constant, or decline slightly, with firm size. We employ a multitask model to discuss implications for the design of control systems.

ABSTRACT We empirically analyze the dynamics of executives' pay‐to‐performance sensitivities. Option pay‐to‐performance sensitivities become weaker as options fall underwater, often leading to pressures to reprice options or restore pay‐to‐performance sensitivity in other ways. Building a detailed data set on executives' portfolios of stock and options, we find that the responsiveness of pay‐to‐performance sensitivities (created by all executive holdings of stock and options) to changes in stock price is large. The elasticity of pay‐to‐performance sensitivities with respect to stock price decreases is about 0.7 and is larger for high‐option executives and for executives with high percentages of options already underwater. The dominant mechanism through which companies offset declines in option pay‐to‐performance sensitivities is larger option grants following stock price declines; on average, these larger grants restore approximately 40% of the stock‐price‐induced pay‐to‐performance sensitivity declines. Option repricings are inconsequential in this regard, despite the attention they have attracted. In looking at positive returns, we find the reverse: higher returns both directly increase pay‐to‐performance sensitivities and lead to larger option grants, which raise pay‐to‐performance sensitivities further. Thus, option grants to executives tend to be largest following large stock price increases or large stock price decreases.

We employ a certainty-equivalence framework to analyze the cost, value and pay/performance sensitivity of non-tradable options held by undiversified, risk-averse executives. We derive “executive value” lines, the risk-adjusted analogues to Black–Scholes lines. We show that distinguishing between “executive value” and “company cost” provides insight into many issues regarding stock option practice including: executive views about Black–Scholes values; tradeoffs between options, restricted stock and cash; exercise price policies; option repricings; early exercise policies and decisions; and the length of vesting periods. It also leads to reinterpretations of both cross-sectional facts and longitudinal trends in the level of executive compensation.

A common view is that there is little correlation between firm performance and CEO pay. Using a new fifteen-year panel data set of CEOs in the largest, publicly traded U. S. companies, we document a strong relationship between firm performance and CEO compensation. This relationship is generated almost entirely by changes in the value of CEO holdings of stock and stock options. In addition, we show that both the level of CEO compensation and the sensitivity of compensation to firm performance have risen dramatically since 1980, largely because of increases in stock option grants.

This paper assesses the relative technical efficiency of institutions operating in a market that has been significantly affected by environmental and market factors in recent years, the Hong Kong banking system. These environmental factors are specifically incorporated into the efficiency analysis using the innovative slacks-based, second stage Tobit regression approach advocated by Fried et al. [Fried, H.O., Schmidt, S.S., Yaisawarng, S., 1999. Incorporating the operating environment into a nonparametric measure of technical efficiency. Journal of Productivity Analysis 12, 249–267]. A further innovation is that we also employ Tone’s [Tone, K., 2001. A slacks-based measure of efficiency in data envelopment analysis. European Journal of Operational Research 130, 498–509] slacks-based model (SBM) to conduct the data envelopment analysis (DEA), in addition to the more traditional approach attributable to Banker, Charnes and Cooper (BCC) [Banker, R.D., Charnes, A., Cooper, W.W., 1984. Some models for estimating technical and scale efficiencies in data envelopment analysis. Management Science 30, 1078–1092]. The results indicate: high levels of technical inefficiency for many institutions; considerable variations in efficiency levels and trends across size groups and banking sectors; and also differential impacts of environmental factors on different size groups and financial sectors. Surprisingly, the accession of Hong Kong to the People’s Republic of China, episodes of financial deregulation, and the 1997/1998 South East Asian crisis do not seem to have had a significant independent impact on relative efficiency. However, the results suggest that the impact of the last-mentioned may have come via the adverse developments in the macroeconomy and in the housing market.

Although exercise prices for executive stock options can be set either below or above the grant-date market price, in practice virtually all options are granted at the money. We offer an economic rationale for this apparent puzzle, by showing that pay-to-performance incentives for risk-averse undiversified executives are typically maximized by setting exercise prices at (or near) the grant-date market price. We provide an operationally useful alternative to Black-Scholes (1973) for the purpose of both valuing executive stock options and measuring the incentives created by options. Our framework has implications not only for exercise-price policies, but also for indexed options, option repricings, exchanges of cash for stock-based compensation, and the design of bonus plans.