This paper examines whether executive compensation enhances shareholder's claims on earnings and valuation in the banking industry. We decompose executive compensation into bonus, salary, and stock option components and find that compensation contracts in the banking industry are generally designed to be performance sensitive when firm performance is an accounting-based measure. Although compensation is ROE sensitive, executive compensation enhances both ROE and stock returns when firm performance measures are modeled endogenously. This conclusion is thus more in line with the disequilibrium hypothesis that executive compensation reduces agency costs and enhances firm value. In addition, it is noted that each individual compensation component does not have the same effect on firm value. Generally speaking, in the short run the weakest connection between compensation and firm performance is detected for salary, while the strongest for bonus. Stock option, however, is the only component that predicts next period's stock return. The finding is consistent with the view that stock option is designed to be long-term incentive compensation.