Letting Go of Norm: How Executive Compensation Can Do Better Than “Best Practices”

Abstract

With executive pay under the media spotlight, the corporate search for “best practices” is in reality a drive toward common practices as cautious boards gravitate toward a safe norm. But are current trends in compensation structure as good for shareholders as they are for the consultants who implement them? This article explores some of these trends and derives some conclusions about their role in shareholder value creation based on detailed data on executive plans and stock price performance for the S&P 500. One key finding is that rewarding managers for profit growth produces higher stock price returns than rewards based on multiple measures or balanced scorecards. Also, the popular practice of adding long-term incentive plans to the compensation mix does not appear to improve long-term performance. Finally, the granting of equity based on the past year's performance rather than in annual fixed-value amounts appears to be good for shareholders 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.