Achieving Pay for Performance

Abstract

This paper uses historical data on relative pay and relative performance to quantify three dimensions of pay for performance: pay leverage (a measure of incentive strength), pay alignment (a measure of correlation) and the pay premium at peer group average performance (a measure of performance adjusted cost). The paper shows median pay leverage and alignment for CEOs, top 5 executives and directors of S&P 1500 companies for the period 1996-2011. The paper also presents a simple pay plan with annual grants of performance shares that provides “perfect” pay for performance (i.e., leverage of 1.0, alignment of 1.0 and a pay premium of 0.0).

Keywords: executive compensation, management incentives, pay for performance, pay leverage, director compensation

JEL Classification: G30, J33, J41, J44, M52