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 dollar pay to peers regardless of performance, weakens this link by rewarding poor stock performance with larger share grants and penalizing strong performance with smaller grants. We provide the first large-sample evidence on CPP and document three main findings. First, CPP adoption has grown significantly, and its accelerated adoption is partially driven by SFAS123R, the 2006 rule requiring stock options expensing. Second, while the higher proportion of equity pay increases short-term wealth sensitivity to stock prices, CPP reduces long-term wealth sensitivity by penalizing strong stock performance with smaller future share grants. Third, traditional governance mechanisms fail to address CPP misalignment, as boards and proxy advisors encourage CEO pay with CPP characteristics. These findings challenge assumptions about rising equity pay strengthening incentive alignment.

Keywords: Executive Compensation, Competitive Pay Policy, Peer Benchmarked Compensation, Corporate Governance, Fixed Value Pay, CEO Wealth Sensitivity

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