Is Pay Too High and are Incentives Too Low? A Wealth-Based Contracting Framework

36 Pages Posted: 30 Jan 2010

See all articles by John E. Core

John E. Core

Massachusetts Institute of Technology (MIT) - Sloan School of Management

Wayne R. Guay

University of Pennsylvania - Accounting Department

Date Written: January 28, 2010

Abstract

In the wake of the recent financial crisis, US executive compensation has, once again, come under fire from regulators, politicians, the financial press, the general public, and some academics. Although the critiques are varied, many identify the level of pay and performance-based incentives as two key areas of concern. And, as is often the case in the wake of a crisis, proposals have been put forward to resolve the “problems” with executive pay and incentives. A deficiency with all of these proposals, however, is the failure to articulate a framework for determining the appropriate level of executive incentives. Rather, the proposals simply discuss ways firms or regulators might get executives to hold greater incentives without identifying how one should determine whether or when an executive has enough (or too much) incentives. In this paper, we lay out an economic framework for thinking about how much performance-based incentives an executive should have. In doing this, we emphasize how performance-based incentives are linked to executive pay levels, as well as to the level of executives’ wealth. We also make clear both the benefits and costs of performance-based incentives.

Keywords: executive compensation, equity incentives, corporate governance, regulation

JEL Classification: G30, G38, J33, M40

Suggested Citation

Core, John E. and Guay, Wayne R., Is Pay Too High and are Incentives Too Low? A Wealth-Based Contracting Framework (January 28, 2010). Available at SSRN: https://ssrn.com/abstract=1544018 or http://dx.doi.org/10.2139/ssrn.1544018

John E. Core

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

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Wayne R. Guay (Contact Author)

University of Pennsylvania - Accounting Department ( email )

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Philadelphia, PA 19104-6365
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215-898-7775 (Phone)
215-573-2054 (Fax)

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