Reforming Executive Compensation: Simplicity, Transparency and Committing to the Long-Term

32 Pages Posted: 16 Nov 2009 Last revised: 16 Dec 2009

Sanjai Bhagat

University of Colorado at Boulder - Department of Finance

Roberta Romano

Yale Law School; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI)

Date Written: October 21, 2009

Abstract

This Article advances an executive compensation reform proposal that is specifically addressed to firms receiving government financial assistance and thought to pose a systemic risk, although we think that all firms should consider its adoption. Executive compensation reform should lead to policies that are simple, transparent, and focused on creating and sustaining long-term shareholder value. With these criteria in mind, we suggest that incentive compensation plans should consist only of restricted stock and restricted stock options, restricted in the sense that the shares cannot be sold nor the options exercised for a period of at least two to four years after an individual resignation or last day in office. We would permit a minor amount to be paid out to executives currently to address tax, liquidity, and premature turnover concerns that the proposal could induce. We believe that this approach will provide superior incentives for executives(and traders whose actions can substantially impact an organization) to manage firms in investors longer-term interest, and diminish their incentive to make public statements, manage earnings, or accept undue levels of risk, for the sake of short-term price appreciation. By reducing management incentive to take on unwarranted risk, our proposal would therefore also decrease the probability that public resources will be dissipated in bailouts of financial firms, particularly those deemed by public officials as “too big to fail.”

Keywords: executive compensation, restricted stock, financial institution regulation, emergency economic stablization act

JEL Classification: G21, G28, G30, G38, K22

Suggested Citation

Bhagat, Sanjai and Romano, Roberta, Reforming Executive Compensation: Simplicity, Transparency and Committing to the Long-Term (October 21, 2009). Yale Law & Economics Research Paper No. 393. Available at SSRN: https://ssrn.com/abstract=1506742 or http://dx.doi.org/10.2139/ssrn.1506742

Sanjai Bhagat (Contact Author)

University of Colorado at Boulder - Department of Finance ( email )

Campus Box 419
Boulder, CO 80309
United States
303-492-7821 (Phone)

Roberta Romano

Yale Law School ( email )

P.O. Box 208215
New Haven, CT 06520-8215
United States
203-432-4965 (Phone)
203-432-4871 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

HOME PAGE: http://www.ecgi.org

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