Letting Go of Norm: How Executive Compensation Can Do Better than 'Best Practices'
31 Pages Posted: 12 Oct 2005 Last revised: 14 May 2009
Date Written: August 1, 2005
With executive compensation in the limelight, the search for best practices has devolved into a drive toward common practices as cautious boards gravitate toward a safe norm. Are these trends in compensation structure as good for the shareholders as they are for the consultants who implement them? Until recently there has been little empirical research to answer such a question. This paper explores some of these trends, and derives some conclusions about their value based on examination of detailed data on executive plans for the S&P 500.
This paper is not concerned with the reasons that compensation structures look the way they do (e.g., executive greed, board capture, market for talent, etc.), nor is it concerned with the issue of high CEO pay per se. Instead, it looks at how these structures as they are work for or against shareholder value creation. Against this standard the record is decidedly mixed.
One key finding is that rewarding managers for (old-fashioned) profit growth produces higher stock price returns than the trend toward rewards based on multiple measures or balanced scorecards. Also, the trend toward adding long-term incentive plans to the compensation mix does not appear to improve long-term performance. Finally, the trend toward granting equity based on past year's performance rather than in annual fixed-value amounts appears to be good for shareholders both because of additional incentives created by performance-based grants as well as the elimination of the perverse incentive of rewarding poor stock price performance with more shares.
Keywords: corporate governance, executive compensation
JEL Classification: G30, L20, M52
Suggested Citation: Suggested Citation