Shifting the Goalposts? Analysing Changes to Performance Peer Groups Used to Determine the Remuneration of FTSE100 CEOs

Rodion Skovoroda,Alistair Bruce

doi:10.2139/ssrn.3367927

Abstract

This paper examines year‐on‐year changes to the composition of performance peer groups used for relative performance evaluation in setting CEO pay in FTSE 100 companies and finds evidence of peer selection bias. The authors find that firms keep their peer groups weak by excluding relatively stronger performing peers. They also show that peer selection bias is less pronounced in firms with higher institutional investor ownership, which suggests that institutional investors might be aware of the risks of peer selection bias. The results suggest that peer group modifications can be viewed, at least in part, as an expression of managerial rent‐seeking.

Highlights

Stock-Based Compensation (SBC) has become an increasingly significant component of executive reward for UK CEOs while the level of detail and complexity in the design of the stock-based element of pay has increased considerably since the mid-1980s (e.g. Buck, Bruce, Main, and Udueni, 2003; Conyon and Schwalbach, 2000; Goergen and Renneboog, 2011; Main, Bruce, and Buck, 1996; Ozkan, 2011; Renneboog and Zhao, 2011)
Whilst the performance benchmarks studied by Lewellen et al were used for disclosure purposes and did not directly affect the levels of top executive pay, in this study, by contrast, we explore relative performance bias in performance peer groups that are used for incentive-based pay, with a potential first order effect on pay in UK firms
We accept Hypothesis 1; evidence suggests that peer group modifications display elements of peer selection bias

Summary

Introduction

Stock-Based Compensation (SBC) has become an increasingly significant component of executive reward for UK CEOs while the level of detail and complexity in the design of the stock-based element of pay has increased considerably since the mid-1980s (e.g. Buck, Bruce, Main, and Udueni, 2003; Conyon and Schwalbach, 2000; Goergen and Renneboog, 2011; Main, Bruce, and Buck, 1996; Ozkan, 2011; Renneboog and Zhao, 2011). Holmstrom, 1979, 1982; Murphy, 1999) views performance-based pay in general and SBC in particular as a key governance mechanism that helps foster incentive alignment between the interests of executives and shareholders. Holmstrom (1979) shows that the efficiency of performance-based pay as an incentive alignment mechanism crucially depends on the amount of useful information that performance measures, such as the firm’s stock price, conveys about CEO actions and about the quality of CEO decisions. Agency theory advocates the use of stock-based RPE on the grounds that it helps “de-noise” CEO effort, insulates risk-averse CEOs from non-firm-specific risks common to the firm’s peers, and makes SBC more efficient (Holmstrom, 1982; Murphy, 1999)

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Conclusion