"How Much Sunlight Does it Take to Disinfect a Boardroom? A Short History of Executive Compensation Regulation in America" 

CESifo Economic Studies, Vol. 55, Nos. 3-4, pp. 434-457, 2009

IAN L. DEW-BECKER, Northwestern University - Department of Economics
Email: i-dew@northwestern.edu

This article reviews the history of executive compensation regulation in America and surveys the literature on the effects of these policies. CEOs are almost exclusively in the top 1% of the pay distribution, and regulation of their pay is seen as a well-targeted way of reducing income inequality. Mandatory disclosure of executive compensation has increased nearly uniformly since 1933. A number of other regulations, including special taxes on CEO pay and rules regarding votes on some pay packages have also been introduced, particularly in the last 20 years. However, there is little solid evidence that any of these policies have had any substantial impact on pay. I also review limited evidence from overseas on ‘Say on Pay’, recently proposed in the US, which would allow nonbinding shareholder votes on CEO compensation. The experiences of other countries have been positive, with tighter linkages between pay and performance and improved communication with investors. Mandatory say on pay would be beneficial in the United States, both increasing shareholder value and making CEO pay fairer, thus reducing the likelihood of passage of other legislation to reduce income inequality, such as higher taxes on the rich.

"In Search of Reasonable Executive Compensation" 

CESifo Economic Studies, Vol. 55, Issue 3-4, pp. 405-433, 2009

EUGENE KANDEL, Hebrew University of Jerusalem - Department of Economics, Centre for Economic Policy Research (CEPR)
Email: mskandel@mscc.huji.ac.il

This article makes several observations on the extent of executive compensation and the forms it takes, relating these to the recent literature. I argue that the magnitude of executive compensation seems excessive in light of a wide range of academic studies. I then propose specific regulatory measures that make compensation transparent and predictable for shareholders. Next, a simple taxation of executive compensation above a certain threshold is proposed; I argue that it is a much more efficient way to deal with the issue, than the current legislation in the United States. Turning to the ‘pay for performance’ paradigm, I argue that it must be applied with great care, as, along with the incentives to exert effort it also provides powerful perverse incentives, which are not immediately obvious, may vary dramatically across firms, and may not be well understood by the compensation committees and academics. I outline the design of several generic contracts appropriate for different environments. Finally, I stipulate that the downside of providing too much ‘pay for performance’ is especially evident in financial industry, which is opaque and subject to contagion, thus compensation contract should play a more important role in financial regulation.

"Executive Compensation, Share Repurchases and Investment Expenditures: Econometric Evidence from U.S. Firms" 

ALOK BHARGAVA, University of Houston - Department of Economics
Email: bhargava@uh.edu

This paper modeled the dynamic inter-relationships between average salary, bonus, and stock options granted to top five executives of approximately 700 U.S. firms in the period 1996-2005 using ExecuComp and Compustat databases. Comprehensive models were also estimated for firms’ share repurchases and research and development and investment expenditures, taking into account simultaneity issues. Simple autoregressive models showed that while salaries increased steadily, the time profiles of bonus and stock options were complex. Second, firms’ total assets, intangible assets, market-to-book value, and share repurchases were positively associated with stock options granted using alternative definitions. Third, stock options exercised in the previous year were significant predictors of firms’ share repurchases. Fourth, share repurchases were negatively and significantly associated with firms’ expenditures on research and development and short-term investments. Finally, previous levels of options granted had non-linear effects on research and development and investment expenditures. Overall, the results indicated that high levels of stock options granted to executives and share repurchases by U.S. firms were unlikely to have beneficial effects for research and development and investment expenditures.

"Taxes and Executive Compensation: Evidence from the 1990s" 

CESifo Economic Studies, Vol. 55, Issue 3-4, pp. 542-568, 2009

PETER KATUŠCÁK, affiliation not provided to SSRN

This article analyzes the effect of personal income taxation on the pay-to-stock-price sensitivity of executive compensation contracts generated by stock option and restricted stock grants. Using Execucomp data for 1992-1996 and variation in the ordinary income marginal tax rate of top earners in the same time period, I find that an increase in the tax rate decreases the pre-tax pay-to-performance sensitivity generated by option grants, whereas stock grant sensitivity is found to be unresponsive to the same change. Even though these results can be explained by joint tax optimization of executives and their employers, they suggest that after-tax incentive provision for executives is quite sensitive to variation in the ordinary income tax rate.

"Paying for Long-Term Performance" 

Harvard Law and Economics Discussion Paper No. 658

LUCIAN A. BEBCHUK, Harvard University - Harvard Law School, National Bureau of Economic Research (NBER), European Corporate Governance Institute (ECGI)
Email: bebchuk@law.harvard.edu
JESSE M. FRIED, Harvard Law School
Email: jfried@law.harvard.edu

Firms and regulators around the world are now seeking to ensure that the compensation of public company executives is tied to long-term results to avoid creating incentives for excessive risk-taking. This paper analyzes how this objective can be best achieved. Focusing on equity-based compensation, the primary component of executive pay packages, we identify how such compensation could be best structured to tie remuneration to long-term results rather than short-term gains that might turn out to be illusory. We also analyze how equity compensation could be best designed to prevent the gaming of equity grants at either the front-end or the back-end.

"Effective Communication on Compensation" 

Governance, No. 191, October 2009

SIMON C. Y. WONG, Northwestern University School of Law, Governance for Owners
Email: simon.wong@law.northwestern.edu

Financial incentives are important tools for aligning the interests of executives and shareholders, particularly in markets with dispersed share ownership where investors struggle to actively monitor management. Today, however, there is widespread investor dissatisfaction with executive compensation, not least the role of the board of directors in setting pay.

This article provides practical suggestions to boards on improving communication with shareholders on compensation arrangements.

"The Relative Efficiency of Clawback Provisions in Compensation Contracts" 

CAROLYN B. LEVINE, Carnegie Mellon University - David A. Tepper School of Business
Email: clevine@andrew.cmu.edu
MICHAEL J. SMITH, Boston University School of Management
Email: msmith22@bu.edu

Clawbacks are retractions of previously-awarded bonuses. In our model, the manager takes a first-period effort that stochastically determines a first-period signal and a second-period cash flow. Both the cash flow and the signal are noisy indicators of effort. The agent can manipulate the signal, i.e., manage earnings. The no-clawback contract pays the agent in the first period for a good signal. The clawback contract also rewards the good signal, but the payment is in the second period and may be lower if the cash realization is low. The agent is impatient and prefers a first-period payment. We find that the no-clawback contract dominates the clawback contract if the cash realization is relatively noisy, earnings management is difficult, or the agent is very impatient. Earnings management may be optimal even though the actual cash realization is contractible. A contract involving restricted stock is always dominated by the clawback contract. The results demonstrate that the optimal ex ante alignment of manager and shareholder interests does not imply perfect ex post alignment of manager and shareholder payoffs.

"Is There a Case for Regulating Executive Pay in the Financial Services Industry?" 

JOHN E. CORE, University of Pennsylvania - Accounting Department
Email: jcore@wharton.upenn.edu
WAYNE R. GUAY, University of Pennsylvania - Accounting Department
Email: guay@wharton.upenn.edu

Since at least as early as the 1950s, the press, general public, politicians, and academic researchers have remarked on the high levels of US CEO pay and questioned whether these levels are fair and appropriate, as well as whether executive compensation provides proper incentives. Undoubtedly, executive compensation and incentives will continue to be a hotly debated issue for years to come and we do not contend to settle these disputes in this article. Rather, we begin by highlighting some basic descriptive analysis of CEO pay levels and incentives, in general, as well as a comparative analysis of CEO pay and incentives in the financial services industry. We then describe recent proposals to regulate executive pay in the financial services industry (and more generally), and discuss the merits of such regulation. In summary, although we agree broadly with regulators’ views on the principles that should guide executive compensation practices, we believe that many of these principles are already engrained in the typical executive compensation plan. We also have serious reservations about whether several of the regulatory proposals would achieve their stated objectives.

"Executive Compensation and Business Policy Choices at U.S. Commercial Banks" 

ROBERT DEYOUNG, University of Kansas School of Business
Email: rdeyoung@ku.edu
MENG YAN, Fordham University
Email: myan@fordham.edu
EMMA Y. PENG, Fordham University
Email: ypeng@fordham.edu

This study examines whether and how the terms of CEO compensation contracts at large commercial banks between 1994 and 2006 influenced, or were influenced by, the risky business policy decisions made by these firms. We find strong evidence that bank CEOs responded to contractual risk-taking incentives by taking more risk; bank boards altered CEO compensation to encourage executives to exploit new growth opportunities; and bank boards set CEO incentives in a manner designed to moderate excessive risk-taking. These relationships are strongest during the second half of our sample, after deregulation and technological change had expanded banks' capacities for risk-taking.