CEO Incentives - It's Not How Much You Pay, But How

15 Pages Posted: 31 Mar 2010  

Michael C. Jensen

Social Science Electronic Publishing (SSEP), Inc.; Harvard Business School; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI)

Kevin J. Murphy

University of Southern California - Marshall School of Business; USC Gould School of Law

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Abstract

In this 1990 Harvard Business Review classic, the authors begin by correcting a number of widespread misconceptions:

• Contrary to headlines at the time, top executives at the end of the 1980s were not receiving record salaries and bonuses. Instead they were catching up to real levels of pay that prevailed during the 1930s and had dropped sharply since then.

• Annual changes in executive compensation during the 1970s and 1980s were largely unrelated to changes in corporate performance, with CEO total compensation varying by only about $3 with every $1,000 change in shareholder wealth. (And the variability of total CEO pay was no higher than that of the compensation of hourly and salaried employees.)

• With respect to pay for performance, U.S. compensation practices in the ’70s and ’80s were getting worse rather than better over time. The percentage of stock ownership by CEOs in large public companies was ten times greater in the 1930s than in the 1980s. And during the previous 15 years (1975–1989), CEO holdings as a fraction of value had actually fallen.

With the aim of reversing these trends, the authors offered three recommendations:

• Substantial equity ownership by CEOs.

• Structuring of cash compensation to provide big rewards for outstanding performance and meaningful penalties for poor performance.

• Increased threat of dismissal for poor performance.

Since publication of this article in 1990, the first and third of these goals have largely been accomplished (while the second has proved more elusive).

Suggested Citation

Jensen, Michael C. and Murphy, Kevin J., CEO Incentives - It's Not How Much You Pay, But How. Journal of Applied Corporate Finance, Vol. 22, No. 1, pp. 64-76, Winter 2010. Available at SSRN: https://ssrn.com/abstract=1581816 or http://dx.doi.org/10.1111/j.1745-6622.2010.00262.x

Michael C. Jensen (Contact Author)

Social Science Electronic Publishing (SSEP), Inc. ( email )

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Harvard Business School ( email )

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HOME PAGE: http://drfd.hbs.edu/fit/public/facultyInfo.do?facInfo=ovr&facId=6484

National Bureau of Economic Research (NBER) ( email )

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European Corporate Governance Institute (ECGI) ( email )

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Belgium

Kevin J. Murphy

University of Southern California - Marshall School of Business ( email )

BRI 308, MC 0804
Los Angeles, CA 90089-0804
United States
213-740-6553 (Phone)
213-740-6650 (Fax)

USC Gould School of Law

699 Exposition Boulevard
Los Angeles, CA 90089
United States

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