Business Strategy and Top Management Compensation: The Mediating Effects of Employment Risk, Firm Performance and Size Rajaram Veliyath zyxwvutsrqponmlkjihgfedcbaZYXWVUTSRQPONMLKJIHGFEDCBA KENNE~AW STATE COLLEGE AND VIRGINIA TECH INSTITUTE AND STATE UNIVERSITY Stephen I? Ferris UNIVERSITY OF MISSOURI-COLUMBIA Kannan Ramaswamy FLORIDA INTERNATIONAL UNIVERSITY We compare top management compensation among prospector, defender, and analyzer strategic types, and the eficts of difirences in managers’ employment risks,firm peuformance, andfirm size. Prospectors performed better and they paid their top management group more than did analyzers. They were also bigger,their managers faced more emplqment risks, and they paid their CEOs more than did defenders or analyzers. Sign$cant d$erences were found among the three strategic types in managers’ employment risks,firm perfrmance, and size. On average, the strategic types whose managersfaced greater employment risks also compensated their top management group more, providing evidence of a positive relationship be- tween risk and return at the level of strategic types. Confirming previous findmgs, firm size constituted the greatest influence zyxwvutsrqponmlkjihgfedcbaZYXWVUTSRQPONMLKJIHGFEDCBA on top management compensation. J BURN RES 1994. 30.149-159 zyxwvutsrqponmlkjihgfedcbaZYXWVUTSRQPONMLKJIHGFEDCBA T op management compensation and pay practices can be seen as corporate governance mechanisms designed to deal with the agency problem (Hoskisson et al., 1989; Tosi and Gomez-Mejia, 1989) as well as a means of promoting managerial motivation and discretion (Finkelstein and Ham- brick, 1988; Lawler, 1984, 1981; Ungson and Steers, 1984). Re- searchers have also explored linkages between top management compensation and: (1) firm size (Ciscel and Carroll, 1980; Finkelstein and Hambrick, 1988; Lambert, Larcker, and Weigelt, 1991), (2) firm performance (Antle and Smith, 1986; Baker, Jensen, and Murphy, 1988; Coughlan and Schmidt, 1985; Gerhart and Milkovich, 1990; Gomez-Mejia, Tosi, and Hinkin, 1987; Murphy, 1985; Pearce, Stevenson, and Perry, 1985; Tosi and Gomez-Mejia, 1989), (3) the executive’s hierarchy position (Rajagopalan and Prescott, 1990; Lambert, Larcker, and Weigelt, 1991; Leonard, 1990), and (5) the firm’s strategic orientation (Balkin and Gomez-Mejia, 1987, 1990; Finkelstein and Ham- Address correspondence to Rajaram Veliyath, Department of Management, Virginia Tech, Blacksburg, VA 24061, Journal of Business Research 30, 149-159 (1994) o Else&r Science Inc. 655 Avenue of the Americas, New York, NY 10010 brick, 1989; Galbraith and Merrill, 1991; Hoskisson et al., 1989; Kerr, 1985; Rajagopalan and Prescott, 1990). Tailoring the compensation of senior executives to the re- quirements of a finris strategy promotes goal congruence through reducing managers’ employment risks (Hoskisson et al., 1989), reducing the extent of agency problems (Fama, 1980; Fama and Jensen, 1983; Jensen and Meckhng, 1976), as well as ensuring successful strategy implementation and control (Brindisi, 1984; Doz and Prahalad, 1981; Galbraith and Nathanson, 1979; Stonich, 1981). This study is an investigation of differences in the amounts of total cash compensation paid to top management at different hierarchy levels among a sample of companies following differ- ent strategies. Because the strategy of the firm affects compen- sation through the employment risks faced by the firm’s managers, as well as through firm performance, the study ex- plores the mediating effects of these variables (i.e., manager’s employment risks and firm performance) on compensation when controlling for firm size. Theoretical Background and Hypotheses The Miles and Snow (1978) typology proposes four strategic archetypes: prospectors, defenders, analyzers, and reactors. Miles and Snow suggest that effective strategic adaptation oc- curs when an organization’s responses to three interrelated adap- tation problems- namely, the entrepreneurial problem, the en- gineering problem, and the administrative problem-are mutually consistent. The administrative problem deals with ex- ecutive appraisal, reward, and compensation mechanisms. This process unfolds for prospectors when they fuel growth by continually searching for new product-market opportuni- ties and focusing heavily on market research and product de- velopment. Their solutions to administrative problems reflect this constant state of flux through frequent changes in top ISSN 0148.2963/94/$7.00