This study considers the determination of the ex ante
pay-performance relationship. A single-period partial equilibrium
model is used to show that the executive income can be expressed as
a function of the firm's return expressed in dollar terms. The
executive income is jointly determined by the opening firm size and
current return, which function as a managerial talent proxy and
self-selection mechanism respectively. Comparing to Jensen and
Murphy (1990) wealth-based Pay-Performance Sensitivity (PPS), this
study presents an income- based PPS. The alternative PPS not only
overcomes a misleading misspecification in Jensen and Murphy
(1990), but also corrects Rosen's (1992) argument for only
including return in the pay performance relationship. This study
finds empirically that both the opening firm size and stock return
play a significant role in determining executive income. This study
provides supplementary evidence to Murphy's (1986) Learning Model.
However, shareholder income may not be an ideal performance measure
in capturing the multi-period pay-performance relationship.
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