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

Brian Bell, Simone Pedemonte and John van Reenen

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: We exploit the large rise in relative performance awards in the United Kingdom over the last two decades to investigate whether these contracts improve the alignment between CEO pay and firm performance. We first document that corporate governance appears to be stronger when institutional ownership is greater. Then, using hand-collected data from annual reports on explicit contracts, we show that (1) CEO pay still responds more to increases in the firms' stock performance than to decreases, and, importantly, this asymmetry is stronger when corporate governance is weak as measured by low institutional ownership; and (2) "pay for luck"persists 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 major reason why relative performance contracts do not eliminate 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 in weakly governed firms. We show the mechanism operates both through the quantum of shares and the structure of new contracts. These findings suggest that reforms to the formal structure of CEO pay contracts are unlikely to align incentives in the absence of strong corporate governance.

JEL-codes: J01 N0 R14 (search for similar items in EconPapers)
Pages: 30 pages
Date: 2021-10-14
New Economics Papers: this item is included in nep-bec, nep-cfn, nep-cta, nep-eur, nep-his and nep-hrm
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

Published in Journal of the European Economic Association, 14, October, 2021, 19(5), pp. 2513 - 2542. ISSN: 1542-4766

Downloads: (external link)
http://eprints.lse.ac.uk/112749/ Open access version. (application/pdf)

Related works:
Journal Article: Ceo Pay and the Rise of Relative Performance Contracts: A Question of Governance? (2021)
Working Paper: CEO pay and the rise of relative performance contracts: a question of governance? (2016)
Working Paper: CEO PAY AND THE RISE OF RELATIVE PERFORMANCE CONTRACTS: A QUESTION OF GOVERNANCE? (2016)
Working Paper: CEO pay and the rise of relative performance contracts:a question of governance (2016)
Working Paper: CEO Pay and the rise of Relative Performance Contracts: A Question of Governance? (2016)
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Persistent link: https://EconPapers.repec.org/RePEc:ehl:lserod:112749

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