Why Do Firms Use Equity-based Pay? Managerial Compensation and Stock Price Informativeness

We study the motive of using equity-based pay in executive compensation: the risk-sharing motive versus the performance-measuring motive. The empirical design goes through the relationship between equity-based pay and stock price informativeness (SPI). We find equity-based pay decreases in SPI, which is consistent with the risk-sharing motive but inconsistent with the performance-measuring motive. The SPI effect on compensation is stronger in financially-constrained firms, more diversified firms, and firms with less product market competition. SPI increases pay efficiency through a larger proportion of option pay, fewer perquisites, and greater pay-for-skill. We address potential endogeneity concerns by investigating the changes in compensation of managers switching between firms with different SPI.

Keywords: Executive compensation, Equity-based pay, Stock price informativeness

JEL Classification: G30, J33

Suggested Citation: Suggested Citation

Bennett, Benjamin and Garvey, Gerald T. and Milbourn, Todd T. and Wang, Zexi, Why Do Firms Use Equity-based Pay? Managerial Compensation and Stock Price Informativeness (May 2, 2019). Fisher College of Business Working Paper No. 2019-03-012, Charles A. Dice Center Working Paper No. 2019-12, Available at SSRN: https://ssrn.com/abstract=3125875 or http://dx.doi.org/10.2139/ssrn.3125875