CEO Pay, Performance, and Value Sharing

Abstract

CEO compensation is a highly controversial subject. While most company directors believe that CEO pay is not a problem, the majority of the American public believes that it is. The difficulties that boards face in justifying CEO pay levels in some ways stem from the challenge of quantifying how much value a CEO creates and how much of this value should be shared as compensation. We examine this topic in detail and ask:

• Why are CEO compensation arrangements not explicitly tied to value creation? • How much does a CEO personally contribute to corporate performance? • How is corporate performance best measured: by change in stock price or change in corporate profits? • What portion of shareholder value creation should a CEO receive in pay? • Why don’t companies explicitly calculate and disclose the relation between value creation and pay?

The Stanford Closer Look series is a collection of short case studies through which we explore topics, issues, and controversies in corporate governance and executive leadership. 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 books Corporate Governance Matters and A Real Look at Real World Corporate Governance.

Keywords: CEO compensation, executive pay, pay for performance, correlation of pay to performance metrics, compensation committees, corporate governance research

JEL Classification: G14, G20, G28, G30, K2