Competitive Target Pay Practices for CEO Compensation

Abstract

The competitive target pay policy sets a target dollar number for total CEO compensation within a specified range of the amounts paid to a CEO’s peers chosen from similar sized firms in the same industry. If such a policy were widely adopted by compensation committees, we would observe a negative cross-sectional association between the stock price performance of a firm and change in the equivalent shares awarded to the CEO. That is exactly what we document in our sample of 21,614 firm-year observations, drawn from Execucomp covering the years 1992 to 2018. We go on to demonstrate, via simulations, that such a practice penalizes the sensitivity of CEO wealth to stock price performance as poor (superior) stock price performance is rewarded (penalized) with larger (smaller) equity grants. Directors’ equity compensation also strongly reflects the adoption of competitive pay policies. Finally, we document that Institutional Support Services (ISS)’s recommendations on CEO pay proposals do not appear to recognize the weakened link between CEO wealth and performance due to competitive pay policy.

Keywords: CEO, compensation, target pay, competitive pay policy, compensation committee, director pay

JEL Classification: G34, G38, J31, J33, J38, K22, K34, M12, M41, M48, M52