Competitive Pay Policies in CEO Compensation

Abstract

CEO equity pay has risen dramatically since 1993, fostering beliefs of increased CEO-shareholder incentive alignment. However, the concurrent rise of “competitive pay policy” (CPP), which benchmarks pay to peers regardless of performance, weakens this link by inversely correlating share grants and stock performance. We document significant recent CPP adoption, particularly after the 2006 rule requiring options expensing. CPP reduces long-term CEO wealth sensitivity to stock prices, despite increasing short-term incentives through greater equity pay.  Governance mechanisms fail to address CPP’s misalignment, as boards and proxy advisors encourage CPP. These findings challenge assumptions about rising equity pay automatically strengthening incentive alignment.

Keywords: CEO compensation, peer benchmarked compensation, target pay, competitive pay policy, corporate governance, proxy advisors, board of director compensation

JEL Classification: G34, G38, J33, J38, M12, M41, M48