Complexity of CEO Compensation Packages
70 Pages Posted: 25 Apr 2022
Date Written: March 25, 2022
Despite claims that CEO compensation contracts are increasingly complex, little is known about the extent to which they are, what drives that complexity, and its implications. We develop a new measure of compensation contract complexity and find that complexity relates to factors capturing firm complexity as well as the inclusion of contract provisions to address principal-agent conflicts. Firms that allow for ex-post renegotiation have simpler contracts, and external pressures are associated with greater contract complexity. We find that complexity has deleterious consequences; compensation complexity is associate with lower future firm performance. And, that relation is stronger when firms face extreme changes in business conditions and when the performance metrics in compensation contracts are weakly correlated, consistent with information overload hampering decision making. The unintended consequences of complexity confirm concerns raised by investors and the media, and our findings may be useful to boards as they design CEO pay packages.
Keywords: CEO compensation, contracts, complexity, incentives, information overload
JEL Classification: J33, M52
Suggested Citation: Suggested Citation