The Effect of Performance Shares on Executive Incentives

Abstract

I examine the determinants of performance share awards (PSAs), focusing on the factors associated with the recent increase in PSA use, and the effects of PSA use on key characteristics of compensation, pay levels and pay-for-performance sensitivity. PSAs are equity awards for which the number of shares that vest varies based on performance compared to pre-determined goals. I find that poor Say-on-Pay voting outcomes are associated with more aggressive adoption of PSAs and that PSAs have primarily replaced stock options in equity awards. Compared to stock options, PSAs have not affected ex ante compensation levels (grant date fair value), but have resulted in ex post payouts that are less variable and no lower. Moreover, PSA payouts increase in measures of CEO power. Collectively, these results support the hypothesis that PSAs are being used to disguise compensation rather than improve incentive alignment.

Keywords: CEO compensation, equity compensation, performance-based equity

JEL Classification: M41, M52, G3