Indexing Executive Compensation Contracts
Review of Financial Studies, Vol. 26, 3182-3224, 2013.
65 Pages Posted: 5 Jul 2011 Last revised: 24 Feb 2021
Date Written: April 25, 2013
We analyze the efficiency of indexing executive pay by calibrating the standard
model of executive compensation to a large sample of US CEOs. The benefits
from linking the strike price of stock options to an index are small and fully indexing
all options would increase compensation costs by about 50% for most firms.
Indexing has several effects with overall ambiguous impact; the quantitatively
most important effect is to reduce incentives, because indexed options pay off
when CEOs’ marginal utility is low. The results also hold if CEOs can extract rents
and extend to the case of indexing shares.
Keywords: executive compensation, indexed options, relative performance evaluation, pay for luck
JEL Classification: G30, M52
Suggested Citation: Suggested Citation