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Sensitivity of CEO Wealth to Stock Price: A New Tool for Assessing Pay for Performance

7 Pages Posted: 18 Sep 2010 Last revised: 3 Sep 2013

David F. Larcker

Stanford University - Graduate School of Business

Brian Tayan

Stanford University - Graduate School of Business

Date Written: September 15, 2010

Abstract

In recent years, there has been considerable debate as to whether CEO compensation is actually correlated with performance in U.S. companies. This issue is known as “pay for performance.” While the debate is often heated, there tends to be little in the way of concrete analysis to inform conclusions.

We explain an important new method for measuring pay for performance. This involves examining the sensitivity of CEO equity ownership to potential large-scale changes in the stock price. We explain how the convexity of this relationship can give shareholders and stakeholders a better understanding of the incentives that the company is offering to its CEO. We also explain that it is important to review this information in the context of the company’s strategy to determine whether potential payments are appropriate and whether they encourage “excessive” risk taking.

Topics, Issues and Controversies in Corporate Governance and Leadership: The Closer Look series is a collection of short case studies through which we explore topics, issues, and controversies in corporate governance. In each study, we take a targeted look at a specific issue that is relevant to the current debate on governance and explain why it is so important. Larcker and Tayan are co-authors of the book Corporate Governance Matters, and A Real Look at Real World Corporate Governance.

Keywords: pay for performance, compensation, risk management, corporate governance

JEL Classification: G30, G34

Suggested Citation

Larcker, David F. and Tayan, Brian, Sensitivity of CEO Wealth to Stock Price: A New Tool for Assessing Pay for Performance (September 15, 2010). Rock Center for Corporate Governance at Stanford University Closer Look Series: Topics, Issues and Controversies in Corporate Governance No. CGRP-10. Available at SSRN: https://ssrn.com/abstract=1678086

David F. Larcker (Contact Author)

Stanford University - Graduate School of Business ( email )

Graduate School of Business
518 Memorial Way
Stanford, CA 94305-5015
United States
650-725-6159 (Phone)

Brian Tayan

Stanford University - Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305-5015
United States

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