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CEO pay and the rise of relative performance contracts:a question of governance

Bell, Brian and Van Reenen, John (2016) CEO pay and the rise of relative performance contracts:a question of governance. CEP Discussion Paper (1439). Centre for Economic Performance, London School of Economics and Political Science, London, UK.

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Abstract

Would moving to relative performance contracts improve the alignment between CEO pay and performance? To address this, we exploit the large rise in relative performance awards and the share of equity pay in the UK over the last two decades. Using new employer-employee matched datasets we find that the CEO pay-performance relationship remains asymmetric: pay responds more to increases in shareholders’ return performance than to decreases. Further, this asymmetry is stronger when governance appears weak. Second, there is substantial “pay-for-luck” as remuneration increases with random positive shocks, even when the CEO has equity awards that explicitly condition on firm performance relative to peer firms in the same sector. A reason why relative performance pay fails to deal with pay for luck is that CEOs who fail to meet the terms of their past performance awards are able to obtain more generous new equity rewards in the future. Moreover, this “compensation effect” is stronger when the firm has weak corporate governance. These findings suggest that reforms to the formal structure of CEO pay contracts are unlikely to align incentives in the absence of strong shareholder governance.

Item Type: Monograph (Discussion Paper)
Official URL: http://cep.lse.ac.uk/
Additional Information: © 2016 The Authors
Divisions: Centre for Economic Performance
Subjects: H Social Sciences > HD Industries. Land use. Labor > HD28 Management. Industrial Management
JEL classification: G - Financial Economics > G3 - Corporate Finance and Governance > G30 - General
J - Labor and Demographic Economics > J3 - Wages, Compensation, and Labor Costs > J31 - Wage Level and Structure; Wage Differentials by Skill, Training, Occupation, etc.
J - Labor and Demographic Economics > J3 - Wages, Compensation, and Labor Costs > J33 - Compensation Packages; Payment Methods
Sets: Research centres and groups > Centre for Economic Performance (CEP)
Date Deposited: 09 Sep 2016 13:52
Last Modified: 13 Sep 2019 23:29
Funders: Economic and Social Research Council, Economic and Social Research Council
URI: http://eprints.lse.ac.uk/id/eprint/67674

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