CEO Pay and the Rise of Relative Performance Contracts: A Question of Governance?

52 Pages Posted: 18 Jul 2016

See all articles by Brian Bell

Brian Bell

London School of Economics & Political Science (LSE)

John Van Reenen

London School of Economics - Centre for Economic Performance (CEP); Stanford Graduate School of Business; Institute for Fiscal Studies (IFS); Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: July 2016

Abstract

Would moving to relative performance contracts improve the alignment between CEO pay and performance? To address this we exploit the large rise in relative performance awards and the share of equity pay in the UK over the last two decades. Using new employer-employee matched datasets we find that the CEO pay-performance relationship remains asymmetric: pay responds more to increases in shareholders' return performance than to decreases. Further, this asymmetry is stronger when governance appears weak. Second, there is substantial 'pay-for-luck' as remuneration increases with random positive shocks, even when the CEO has equity awards that explicitly condition on firm performance relative to peer firms in the same sector. A reason why relative performance pay fails to deal with pay for luck is that CEOs who fail to meet the terms of their past performance awards are able to obtain more generous new equity rewards in the future. Moreover, this 'compensation effect' is stronger when the firm has weak corporate governance. These findings suggest that reforms to the formal structure of CEO pay contracts are unlikely to align incentives in the absence of strong shareholder governance.

Keywords: CEO, equity plans, incentives, Pay

JEL Classification: G30, J31, J33

Suggested Citation

Bell, Brian and Van Reenen, John Michael, CEO Pay and the Rise of Relative Performance Contracts: A Question of Governance? (July 2016). CEPR Discussion Paper No. DP11385. Available at SSRN: https://ssrn.com/abstract=2811080

Brian Bell (Contact Author)

London School of Economics & Political Science (LSE) ( email )

Houghton Street
London, WC2A 2AE
United Kingdom

John Michael Van Reenen

London School of Economics - Centre for Economic Performance (CEP) ( email )

Houghton Street
London WC2A 2AE
United Kingdom
+44 20 7955 6976 (Phone)
+44 20 7955 6848 (Fax)

Stanford Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305-5015
United States

Institute for Fiscal Studies (IFS) ( email )

7 Ridgmount Street
London, WC1E 7AE
United Kingdom
+44 20 7240 6740 (Phone)
+44 20 7240 6136 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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