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90 Cents of Every 'Pay-For-Performance' Dollar Are Paid for Luck

28 Pages Posted: 13 Sep 2016  

Moshe Levy

Hebrew University of Jerusalem - Jerusalem School of Business Administration

Date Written: September 11, 2016

Abstract

We empirically estimate that approximately 90% of standard option-based compensation constitutes pay-for-luck. This value is very robust, and stems from the inherent fact that chance plays a dominant role in determining firm performance. The impact of a manager on her expected compensation via the improvement of firm performance is low, hence, in contrast to common wisdom, standard option-based compensation does not constitute a strong motivating force for rational managers. Indexing and a high strike price can double an option’s motivational power.

Keywords: Executive Compensation, Pay for Performance, Pay for Luck, Employee Stock Options, Managerial Talent, Incentives

JEL Classification: M12, G34

Suggested Citation

Levy, Moshe, 90 Cents of Every 'Pay-For-Performance' Dollar Are Paid for Luck (September 11, 2016). Available at SSRN: https://ssrn.com/abstract=2837504 or http://dx.doi.org/10.2139/ssrn.2837504

Moshe Levy (Contact Author)

Hebrew University of Jerusalem - Jerusalem School of Business Administration ( email )

Mount Scopus
Jerusalem, 91905
Israel

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