Six Factors that Explain Executive Pay (and its Problems)

Abstract

The authors start by showing that six factors - responsibility (i.e., position and company size), industry, pay inflation, business risk, performance and company pay policy - explain over 75% of the variation in the pay of top-five U.S. executives for a sample of 75,000 cases during the years 1997–2008. They also show that the current structure of top-executive pay creates a stronger incentive for revenue growth than for shareholder value growth, and that a 10% increase in shareholder value increases incentive compensation by only 3%. Moreover, their research suggests that the “value incentive” of the average U.S. executive is only one third as strong as the incentive that would be provided by simple “sharing” concepts, such as those provided by plans that give executives a fixed percentage of economic profit or annual grants of a fixed number of shares of stock. The article concludes by reviewing some recent research on incentives and company performance and offering suggestions to help investors identify companies with strong and cost-efficient shareholder value incentives.