Paying for Long-Term Performance

46 Pages Posted: 14 Jan 2010 Last revised: 8 Oct 2010

See all articles by Lucian A. Bebchuk

Lucian A. Bebchuk

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

Jesse M. Fried

Harvard Law School; European Corporate Governance Institute (ECGI)

Date Written: December 1, 2009

Abstract

Firms, investors, and regulators around the world are now seeking to ensure that the compensation of public company executives is tied to long-term results, in part to avoid incentives for excessive risk taking. This Article examines how best to achieve this objective. Focusing on equity-based compensation, the primary component of executive pay, we identify how such compensation should best be structured to tie pay to long-term performance. We consider the optimal design of limitations on the unwinding of equity incentives, putting forward a proposal that firms adopt both grant-based and aggregate limitations on unwinding. We also analyze how equity compensation should be designed to prevent the gaming of equity grants at the front end and the gaming of equity dispositions at the back end. Finally, we emphasize the need for widespread adoption of limitations on executives’ use of hedging and derivative transactions that weaken the tie between executive payoffs and the long-term stock price that well-designed equity compensation is intended to produce.

Keywords: executive compensation, executive pay, equity-based compensation, restricted shares, options, risk-taking, long-term, retention, backdating, spring-loading, unloading, insider trading, hedging, derivatives

JEL Classification: G28, K23

Suggested Citation

Bebchuk, Lucian A. and Fried, Jesse M., Paying for Long-Term Performance (December 1, 2009). University of Pennsylvania Law Review, Vol. 158, pp. 1915-1959, 2010, Harvard Law and Economics Discussion Paper No. 658, Available at SSRN: https://ssrn.com/abstract=1535355 or http://dx.doi.org/10.2139/ssrn.1535355

Lucian A. Bebchuk (Contact Author)

Harvard Law School ( email )

Cambridge, MA 02138
United States
617-495-3138 (Phone)
617-812-0554 (Fax)

HOME PAGE: http://www.law.harvard.edu/faculty/bebchuk/

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
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National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
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United States

Jesse M. Fried

Harvard Law School ( email )

1575 Massachusetts
Griswold Hall 506
Cambridge, MA 02138
United States
617-384-8158 (Phone)

HOME PAGE: http://www.law.harvard.edu/faculty/directory/10289/Fried

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

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