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

Brian Bell and John van Reenen ()

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

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.

Keywords: CEO; pay; incentives; equity plans (search for similar items in EconPapers)
JEL-codes: G30 J31 J33 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-bec, nep-cfn, nep-hrm, nep-lma and nep-sog
Date: 2016-07
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http://eprints.lse.ac.uk/67674/ Open access version. (application/pdf)

Related works:
Working Paper: CEO Pay and the Rise of Relative Performance Contracts: A Question of Governance? (2016) Downloads
Working Paper: CEO Pay and the Rise of Relative Performance Contracts: A Question of Governance? (2016) Downloads
Working Paper: CEO Pay and the rise of Relative Performance Contracts: A Question of Governance? (2016) Downloads
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