Executive Compensation Arrangements Research Articles

Executive Compensation Tied to ESG Performance: International Evidence

ABSTRACTUsing a wide sample of international publicly traded firms, this paper studies the rapidly increasing practice of incorporating Environmental, Social, and Governance (ESG) metrics in executive compensation contracts. Our evidence suggests that this compensation practice varies at the country, industry, and firm levels in ways that are consistent with efficient incentive contracting. We also observe that reliance on ESG metrics in executive compensation arrangements is associated with engagement, voting, and trading by institutional investors, which suggests that firms could be adopting this practice to align their management's objectives with the preferences of certain shareholder groups. Finally, we find that the adoption of ESG Pay is accompanied by improvements in key ESG outcomes, but not by improvements in financial performance.

Stock Buybacks as an Executive Compensation Problem

This Article is the first academic study to systematically analyze the overall sensitivity of executive compensation to stock buybacks. Specifically, my analysis of executive compensation arrangements of CEOs included in the S&P 500 Index reveals that buybacks can enhance a record high portion of incentive compensation, corresponding, on average, to one-third of total CEO pay. I further show that, despite the focus of financial economists on the ability of buybacks to mechanically improve per share performance measures that determine executives’ annual bonuses, repurchases can, in addition and to a much greater extent, boost performance measures that decide executives’ long-term incentive awards. I argue, first, that because a buyback can increase pay even when it would destroy firm value, executives are motivated to conduct buybacks excessively. Second, I explain that this potential motivates executives to game their incentive compensation arrangements and turn them from pay for performance into pay for manipulation. Third, I find that the impacts of buybacks on executive pay are camouflaged in firms’ public filings. These distorted incentives and the lack of transparency are likely to lead firms to underinvest in productive capabilities, disguise poor financial performance, and contribute to the creation of a market bubble that increases the likelihood of another financial crisis. Borrowing from dividend protection, which safeguards executive stock and option awards from the automatic decline in the stock price that dividends trigger, I suggest applying buyback protection, which would shield executive pay from the mechanical performance improvement that stock buybacks stimulate. Because I do not expect a mandatory rule requiring firms to adopt buyback protection to be effective I propose a novel regulatory reform to make the impact of stock buybacks on executive pay transparent. Transparency can be expected to push boards, shareholders, and proxy advisors to pressure firms to adopt buyback protection.

Carrots and sticks in bank governance: time for a bigger stick?

Purpose This paper aims to investigate how bank governance can be altered to reduce risk taking and engender greater financial stability. Design/methodology/approach The paper reviews existing bank governance arrangements, contemporary challenges and alternative reforms. Findings It is argued that recent reforms are incomplete. Greater countervailing incentives for bank managers and shareholders are required. This prompts an inquiry into the merits and demerits of four types of reform: changes to executive compensation arrangements; the introduction of a liability standard for directors; the removal of limited liability for bank shareholders; and a criminal offence for managers. Originality/value Discussion illumines several problems with the current approach to bank governance and provides insights that can help direct future reform.

Carrots and Sticks in Bank Governance: Time for a Bigger Stick?

This paper is pre-occupied with how bank governance can be altered to reduce risk taking and engender greater financial stability. Its approach is to review existing bank governance arrangements, contemporary challenges, and alternative reforms. It is argued that recent reforms are incomplete. Greater countervailing incentives for bank managers and shareholders are required. This prompts an inquiry into the merits and demerits of four types of reform: changes to executive compensation arrangements; the introduction of a liability standard for directors; the removal of limited liability for bank shareholders; and a criminal offence for managers. Discussion illumines several problems with the current approach to bank governance and provides insights that can help direct future reform.

Can the Design of CEO Rewards Be Relied upon to Overcome the Agency Problem Created by the Separation of Ownership and Control?

The structure and design of executive compensation arrangements has become a very sensitive and diverse topic in recent years. The pressure to get executive pay right is attracting great attention higher than before especially in the UK, due to the current political environment triggered by the Brexit (Lang, 2016). This article is the brief analysis on the CEO rewards to overcome the agency problem created by the separation of ownership and control. The analysis carries forward through the agency theory, human theory and expectancy theory. Additionally, this article answering the agency problem due to the separation of ownership and control. After the extensive analysis identified in this journal, even though the design of executive remuneration is a partial remedy to this menace, it is apparent that the performance-related pay is considered as the solution to mitigate the principal-agency conflicts.Additionally, an extra layer monitoring at executive board level may ensure the goal congruence of a firm.

Role of CEO Age in Determining Executive-employee Pay Gap in Chinese Listed Manufacturing Companies: A Perspective of Risk Aversion

The paper investigates the effect of CEO age on executive-employee pay gap (EEPG), a newly focused dimension of executive compensation arrangements by the literature, by choosing the panel data consisting of 3495 firm-years in Chinese listed manufacturing companies during 2010-2014 as the research sample. Empirical analysis based on multiple regression analysis adopting the method of OLS by applying SPSS19.0 makes a new finding, i.e., there is a positive relationship between CEO age and EEPG, which holds robust with the change of the measures. Further investigation on the determination mechanism of CEO age on EEPG show that older CEOs intend to set relatively lower EEPG out of their risk aversion needs.

Reliability Makes Accounting Relevant: A Comment on the IASB Conceptual Framework Project

In July 2013, the International Accounting Standards Board (IASB) welcomed comments to their discussion paper A Review of the Conceptual Framework for Financial Reporting. We argue that the IASB should revisit its decisions about the concepts of reliability and prudence, to address the inherent accounting issue of moral hazard. Within the contexts of goodwill and securitization accounting, we illustrate how reliability and prudence can help standard-setters to identify standards that can address moral hazard. We further illustrate the pervasiveness of moral hazard, using the context of executive compensation arrangements. Ultimately, we conclude that a strong conceptual framework should enhance the credibility of financial reporting. We view this as the fundamental role of accounting.

Reliability Makes Accounting Relevant: A Comment on the IASB Conceptual Framework Project

In July 2013, the International Accounting Standards Board (IASB) welcomed comments to their discussion paper A Review of the Conceptual Framework for Financial Reporting. We argue that the IASB should revisit its decisions about the concepts of reliability and prudence, to address the inherent accounting issue of moral hazard. Within the contexts of goodwill and securitization accounting, we illustrate how reliability and prudence can help standard-setters to identify standards that can address moral hazard. We further illustrate the pervasiveness of moral hazard, using the context of executive compensation arrangements. Ultimately, we conclude that a strong conceptual framework should enhance the credibility of financial reporting. We view this as the fundamental role of accounting.

Executive Compensation: A Model of Disclosure Choice

AbstractRecent public policy debates have led to increased calls for full transparency of executive compensation. However, in practice, many firms are reluctant to disclose the full details of how they link executive compensation to performance. One possible reason for lack of full disclosure is that managers use their power to hide the details of their compensation plan in order to disguise opportunistic rent extraction. If this is the reason for secrecy, then public policy designed to force firms to provide full disclosure is unlikely to be resisted by shareholders. However, another possible explanation for less than full transparency is that some degree of secrecy about executive compensation may be in the interest of the company and its shareholders. If this explanation is correct, then public policy moves to increase transparency may be met by counter moves designed to protect managers and shareholders from such policies.In this paper we investigate if full disclosure of executive compensation arrangements is always optimal for shareholders. We develop a model where optimal executive remuneration solves a moral hazard problem. However, the degree to which the moral hazard problem affects the shareholders depends on hidden information, so that disclosure of the executive compensation scheme will typically reveal the hidden information, which can be harmful to shareholders. The model derives, therefore, the optimal disclosure policy and the optimal remuneration scheme. We find that the shareholders are better off pre‐committing not to disclose the executive compensation scheme whenever possible. Executive directors are shown to be better off too in the absence of disclosure of executive compensation schemes. An argument for mandating disclosure is that it provides better information to shareholders but our analysis demonstrates that disclosure does not necessarily achieve this objective.The results suggest that less than full disclosure can be in the interest of shareholders, the reason for this being that disclosures cannot be made selectively to shareholders but will also be made to strategic opponents. This will be the case if the board of directors and the remuneration committee includes enough independent directors. Whether or not non‐disclosure to shareholders is in their interest is however an empirical matter involving a trade‐off between the proprietary costs associated with disclosure to shareholders and the costs of potential collusion between executive and non‐executive directors associated with non‐disclosure.

Section 457 Deferred Compensation Plans

There are two types of deferred compensation plans allowed under Section 457 of the Internal Revenue Code. They receive little attention in the benefits media, yet they are of considerable importance to certain employers and their employees. Section 457(b) plans are similar to the better known 401(k) and 403(b) but with important differences that make them important to state and local governments, especially for their public safety employees, and to certain other tax-exempt organizations. Section 457(f) plans are more akin to executive compensation arrangements that are predicated on the achievement of specified objectives or performance. Since the addition of Section 409A to the Internal Revenue Code in 2004 (effective 2005), 457(f) plans have been under scrutiny as to whether the compensation deferred is at substantial risk. This article examines both types of Section 457 plans.

Executive Pay, Innovation, and Risk-Taking

This paper analyzes the optimal executive pay arrangement in a setting in which the CEO must be motivated to search for innovative investment ideas and, if he uncovers one, to implement the idea if and only if it is not excessively risky. I show that, depending on the value of the firm's potential growth opportunities and the CEO's concern about being fired, the CEO is either tempted to overinvest in risky ideas (excessive risk-taking) or underinvest in risky ideas (excessive conservatism). The optimal pay package consists of stock options, to encourage the discovery of innovative ideas, and either restricted stock, to combat excessive risk-taking, or severance pay, to combat excessive conservatism. The model provides new empirical predictions regarding the determinants of executive compensation arrangements and analyzes how the change in the economic environment caused by the current financial crisis might change the optimal mix of stock options, restricted stock, and severance pay.

Contingent Capital in Executive Compensation

Contingent capital has great potential to improve corporate governance in Systemically Important Financial Institutions (SIFIs). Early initiatives by European SIFIs to include contingent convertible bonds in executive compensation packages lack governance improving designs. This article suggests the use of contingent convertible bonds with an early conversion trigger in executive compensation. The proposal adds an important element to the literature on inside debt and the creditor-centered approach to executive compensation. Contingent convertible bonds with early triggers could be preferable to other debt instruments because, in addition to lowering income inequality and increasing sustainability, the early trigger design can improve incentives for executives to lower risk taking, improve signaling of default risk, and increase incentives for monitoring by creditors and shareholders. The recognition of ownership characteristics in design features adds an important element to the literature on contingent capital trigger designs. The methodological assumptions of incomplete contract theory can improve the analysis of executive compensation arrangements.

Pay for Regulator Performance

Few doubt that executive compensation arrangements encouraged the excessive risk taking by banks that led to the recent Financial Crisis. Accordingly, academics and lawmakers have called for the reform of banker pay practices. In this Article, we argue that regulator pay is to blame as well, and that fixing it may be easier and more effective than reforming banker pay. Regulatory failures during the Financial Crisis resulted at least in part from a lack of sufficient incentives for examiners to act aggressively to prevent excessive risk. Bank regulators are rarely paid for performance, and in atypical cases involving performance bonus programs, the bonuses have been allocated in highly inefficient ways. We propose that regulators, specifically bank examiners, be compensated with a debt-heavy mix of phantom bank equity and debt, as well as a separate bonus linked to the timing of the decision to take over a bank. Our pay-for-performance approach for regulators would help reduce the incidence of future regulatory failures.

Pay for Regulator Performance

Few doubt that executive compensation arrangements encouraged the excessive risk taking by banks that led to the recent Financial Crisis. Accordingly, academics and lawmakers have called for the reform of banker pay practices. In this Article, we argue that regulator pay is to blame as well, and that fixing it may be easier and more effective than reforming banker pay. Regulatory failures during the Financial Crisis resulted at least in part from a lack ofsufficient incentives for examiners to act aggressively to prevent excessive risk. Bank regulators are rarely paid for performance, and in atypical cases involving performance bonus programs, the bonuses have been allocated in highly inefficient ways. We propose that regulators, specifically bank examiners, be compensated with a debt-heavy mix of phantom bank debt and equity, as well as a separate bonus linked to the timing of the decision to take over a bank. Our pay-forperformance approach for regulators would help reduce the incidence of future regulatory failures. * Professor of Law, University of Chicago Law School (toddh@uchicago.edu). t Howard Zhang Faculty Research Scholar and Professor of Law, Boston University School of Law (fredtung@bu.edu). For helpful comments, we are grateful to Robert Bench, Eric Biber, Chris Brummer, Abe Cable, Anthony Casey, John Crawford, Aziz Huq, Saul Levmore, Anup Malani, Susan Morse, Eric Posner, Eric Rasmusen, Amanda Rose, Larry Ribstein, David Walker, and Charles Whitehead, as well as workshop participants at Boston College Law School, Pace University School of Law, University of Chicago Law School, and the 2011 Roger Traynor Summer Professorship Program at Hastings College of the Law. Osama Hamdy, University of Chicago Law School 2012, provided excellent research assistance.

Merger and acquisition related determinants of executive compensation arrangements' adoption

Previous research has investigated the links between Mergers and Acquisitions (M&As) and the monetary magnitude of executive compensation, but failed to inquire how the adoption of specific attributes of compensation contacts relates to M&A activities. We address this gap in the literature by examining the impacts of some M&A characteristics and acquirers' features on the adoption of executive compensation protection provisions and new Long-Term Incentive Plans (LTIPs). The study adopts a longitudinal design before?after M&A deals for 80 Canadian acquiring companies that engaged in M&A activities between 1995 and 2001. Our findings suggest that both transactional and organisational characteristics significantly explain the executive compensation arrangements' adoption around M&A transactions, but that the adoption of new LTIPs is subjected to a different set of determinants than the adoption of compensation protection provisions. We interpret these results in the light of the agency, political and institutional perspectives.

Positive Corporate Governance and its Implications for Executive Compensation

As a result of a series of high-profile corporate collapses worldwide, along with regular reporting of shareholder money being spent on corporate jets, executive golf days and increasingly excessive executive compensation arrangements, the common perception is that the executives of our largest corporations are driven by self-interest with little regard for what is best for the corporation. Due to this negative perception, there has been an exponential increase in the amount of laws, rules and guidelines setting in place a heightened standard of corporate governance best practice. Without such regulation, it is believed, another collapse or scandal is inevitable. In this article, I dispute this reasoning. In my view if we embrace “positive corporate governance”, in which the positive strengths and virtues of company executives are emphasised, we can move towards an environment in which heavy regulation is replaced by positive corporate norms inside the corporation. I then apply my approach of positive corporate governance to address one of the most significant issues confronting corporate regulation at present- how to deal with the rapid increase in executive compensation in our largest corporations. I suggest that the dominant methodology of pay for performance is ultimately flawed.

Executive Compensation at Fannie Mae: A Case Study of Perverse Incentives, Nonperformance Pay, and Camouflage

This paper is a case study of Fannie Mae's executive compensation arrangements during the period 2000-2004. We identify and analyze four problems with these arrangements:- First, by richly rewarding executives for reporting higher earnings, without requiring return of the compensation if earnings turned out to be misstated, Fannie Mae's arrangement provided perverse incentives to inflate earnings.- Second, Fannie Mae's arrangements provided soft landings to executives who were pushed out by the board for failure; expectation of such outcome adversely affected ex ante incentives.- Third, even if the executives had retired after years of unblemished service, the value of their retirement packages would have been largely unrelated to their own performance.- Fourth, both when promising retirement payments to executives and when making theses payments, Fannie Mae's disclosures obscured rather than made transparent the total values of the executives' retirement packages.Because many other companies have practices similar to Fannie Mae's, our case study highlights some general problems with existing pay practices and the need for reform.

Is U.S. CEO Compensation Inefficient Pay without Performance?

In this paper, we review Pay Without Performance by Professors Lucian Bebchuk and Jesse Fried. The book develops and summarizes the leading critiques of current executive compensation practices in the U.S., and offers a negative, if mainstream, assessment of the state of U.S. executive compensation: U.S. executive compensation practices are failing, and systemic reform is needed. This review summarizes the book in some detail and offers some counter-arguments. The book's thesis is that executive compensation practices are bad for shareholders (not optimal) because they are the product of Managerial power arises because boards of directors at public companies are not independent of executives. Weak compensation committees thus do little to protect the firm in its negotiations with the CEO, leading to levels of executive that are both inappropriately high and have inappropriately low levels of incentives. The authors offer a four part analysis of CEO pay. First, they describe and critique optimal contracting theory, which posits that executive compensation arrangements are designed to benefit shareholders. Second, they explain managerial power theory, in part through an in-depth analysis of current executive compensation practices. They assert the managerial power theory provides a superior explanation of current practices to the optimal contracting perspective. They also draw the strong implication that if managerial power exists, it means that something is wrong with the contracting process. Third, they claim that CEO compensation does not vary sufficiently with firm They conclude with policy recommendations for changing compensation plans and improving corporate governance, for example by requiring that directors be more independent. We agree that it is useful to consider the effect of managerial power on compensation, but we disagree with their interpretation of the consequences of this power. It is true that contract structures reflect CEO power, and that CEOs with more power get more pay, but this does not necessarily lead to the conclusion that CEO is not optimized for shareholders, nor does it imply that CEO needs reform. We show that in many settings where managerial power exists, observed contracts anticipate and try to minimize the costs of this power, and therefore may in fact be written optimally. As a result, the optimal contracting and managerial power perspectives are complementary, and not competing, explanations. We next examine Bebchuk and Fried's claim that U.S. compensation is inefficient pay without performance. Their analysis focuses on whether CEO annual varies with firm While the book conducts an extensive analysis of the incentives provided by annual grants of stock options and equity it largely ignores the main source of CEO incentives: Large holdings of stock and options. These large equity holdings provide powerful incentives and ensure that the wealth of most CEOs varies strongly with their firm's stock price. The books' claim that CEO compensation is pay without performance does not appear correct once one considers this main source of CEO incentives. U.S. executives have very large pay-performance incentives, and their overall levels do not seem inappropriate. We conclude by examining some of Bebchuk and Fried's policy recommendations. Bebchuk and Fried have missed some important aspects of executive and incentives. They have not shown that there are systematic failures with U.S. CEO compensation, and therefore have not shown that reform is needed.

Managerial Power and Rent Extraction in the Design of Executive Compensation

This paper develops an account of the role and significance of managerial power and rent extraction in executive compensation. Under the optimal contracting approach to executive compensation, which has dominated academic research on the subject, pay arrangements are set by a board of directors that aims to maximize shareholder value. In contrast, the managerial power approach suggests that boards do not operate at arm's length in devising executive compensation arrangements; rather, executives have power to influence their own pay, and they use that power to extract rents. Furthermore, the desire to camouflage rent extraction might lead to the use of inefficient pay arrangements that provide suboptimal incentives and thereby hurt shareholder value. The authors show that the processes that produce compensation arrangements, and the various market forces and constraints that act on these processes, leave managers with considerable power to shape their own pay arrangements. Examining the large body of empirical work on executive compensation, the authors show that managerial power and the desire to camouflage rents can explain significant features of the executive compensation landscape, including ones that have long been viewed as puzzling or problematic from the optimal contracting perspective. The authors conclude that the role managerial power plays in the design of executive compensation is significant and should be taken into account in any examination of executive pay arrangements or of corporate governance generally.

Managerial Power and Rent Extraction in the Design of Executive Compensation

This Article develops an account of the role and significance of managerial power and rent extraction in executive compensation. Under the optimal contracting approach to executive compensation, which has dominated academic research on the subject, pay arrangements are set by a board of directors that aims to maximize shareholder value. In contrast, the managerial power approach suggests that boards do not operate at arm’s length in devising executive compensation arrangements; rather, executives have power to influence their own pay, and they use that power to extract rents. Furthermore, the desire to camouflage rent extraction might lead to the use of inefficient pay arrangements that provide suboptimal incentives and thereby hurt shareholder value. The authors show that the processes that produce compensation arrangements, and the various market forces and constraints that act on these processes, leave managers with considerable power to shape their own pay arrangements. Examining the large body of empirical work on executive compensation, the authors show that managerial power and the desire to camouflage rents can explain significant features of the executive compensation landscape, including ones that have long been viewed as puzzling or problematic from the optimal contracting perspective. The authors conclude that the role managerial power plays in the design of executive compensation is significant and should be taken into account in any examination of executive pay arrangements or of corporate governance generally.