This file is part of IDEAS, which uses RePEc data


[ Papers | Articles | Software | Books | Chapters | Authors | Institutions | JEL Classification | NEP reports | Search | New papers by email | Author registration | Rankings | Volunteers | FAQ | Blog | Help! ]

Asymmetric Benchmarking in Compensation: Executives are Paid for (Good) Luck But Not Punished for Bad

Author info | Abstract | Publisher info | Download info | Related research | Statistics
Author Info
Gerald T. Garvey (Drucker Graduate School of Management, Claremont Graduate University)
Todd T. Milbourn (Olin School of Business, Washington University)
Abstract

Principal-agent theory suggests that a manager should be paid relative to a benchmark that captures the effect of market or sector performance on the firm's own performance. Recently, it has been argued that we do not observe such indexation in the data because executives can set pay in their own interests, that is, they can enjoy "pay for luck" as well as "pay for performance". We first show that this argument is flawed. The positive expected return on stock markets reflects compensation for bearing systematic risk. If executives' pay is tied to market movements, they can only expect to receive the market-determined return for risk-bearing. We then reformulate the argument in a more appropriate fashion. If managers can truly influence the nature of their pay, they will seek to have their pay benchmarked only when it is in their interest, namely when the benchmark has fallen. Using a variety of market and industry benchmarks, we find that there is essentially no indexation when the benchmark return is up, but uncover substantial indexation when the benchmark has turned downwards. These empirical results are robust to a variety of alternative hypotheses and robustness checks, and suggest an increase in expected direct compensation of approximately $75,000 for the median executive in our sample, or about 5% of total compensation.

Download Info
To download:

If you experience problems downloading a file, check if you have the proper application to view it first. Information about this may be contained in the File-Format links below. In case of further problems read the IDEAS help file. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL: http://econ.claremontmckenna.edu/papers/2003-01.pdf
File Format: application/pdf
File Function:
Download Restriction: no

Publisher Info
Paper provided by Claremont Colleges in its series Claremont Colleges Working Papers with number 2003-01.

Download reference. The following formats are available: HTML, plain text, BibTeX, RIS (EndNote), ReDIF
Length:
Date of creation: Jan 2003
Date of revision:
Handle: RePEc:clm:clmeco:2003-01

Contact details of provider:
Postal: 500 E. 9th Street, Claremont, CA 91711
Phone: (909) 607-3041
Fax: (909) 621-8249
Web page: http://www.claremontmckenna.edu/econ/papers/
More information through EDIRC

For technical questions regarding this item, or to correct its listing, contact: ().

Related research
Keywords:

This paper has been announced in the following NEP Reports:

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Holmstrom, Bengt & Milgrom, Paul, 1987. "Aggregation and Linearity in the Provision of Intertemporal Incentives," Econometrica, Econometric Society, vol. 55(2), pages 303-28, March. [Downloadable!] (restricted)
    Other versions:
  2. Demsetz, Harold & Lehn, Kenneth, 1985. "The Structure of Corporate Ownership: Causes and Consequences," Journal of Political Economy, University of Chicago Press, vol. 93(6), pages 1155-77, December. [Downloadable!] (restricted)
  3. Daniel N. Deli, 2002. "Mutual Fund Advisory Contracts: An Empirical Investigation," Journal of Finance, American Finance Association, vol. 57(1), pages 109-133, 02. [Downloadable!] (restricted)
  4. Brian J. Hall & Jeffrey B. Liebman, 1998. "Are CEOs Really Paid Like Bureaucrats?," The Quarterly Journal of Economics, MIT Press, vol. 113(3), pages 653-691, August. [Downloadable!] (restricted)
    Other versions:
  5. Bebchuk, Lucian Arye & Fried, Jesse & Walker, David I, 2002. "Managerial Power and Rent Extraction in the Design of Executive Compensation," CEPR Discussion Papers 3558, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
  6. Paul Oyer, 2004. "Why Do Firms Use Incentives That Have No Incentive Effects?," Journal of Finance, American Finance Association, vol. 59(4), pages 1619-1650, 08. [Downloadable!] (restricted)
    Other versions:
  7. Hermalin, Benjamin E & Weisbach, Michael S, 1998. "Endogenously Chosen Boards of Directors and Their Monitoring of the CEO," American Economic Review, American Economic Association, vol. 88(1), pages 96-118, March. [Downloadable!] (restricted)
    Other versions:
  8. Garvey, Gerald T, 1997. " Marketable Incentive Contracts and Capital Structure Relevance," Journal of Finance, American Finance Association, vol. 52(1), pages 353-78, March. [Downloadable!] (restricted)
  9. Rajesh K. Aggarwal & Andrew A. Samwick, 1999. "The Other Side of the Trade-off: The Impact of Risk on Executive Compensation," Journal of Political Economy, University of Chicago Press, vol. 107(1), pages 65-105, February. [Downloadable!] (restricted)
    Other versions:
  10. Haubrich, Joseph G, 1994. "Risk Aversion, Performance Pay, and the Principal-Agent Problem," Journal of Political Economy, University of Chicago Press, vol. 102(2), pages 258-76, April. [Downloadable!] (restricted)
    Other versions:
  11. Jin, Li, 2002. "CEO compensation, diversification, and incentives," Journal of Financial Economics, Elsevier, vol. 66(1), pages 29-63, October. [Downloadable!] (restricted)
  12. Gibbons, Robert & Murphy, Kevin J, 1992. "Optimal Incentive Contracts in the Presence of Career Concerns: Theory and Evidence," Journal of Political Economy, University of Chicago Press, vol. 100(3), pages 468-505, June. [Downloadable!] (restricted)
    Other versions:
  13. Garen, John E, 1994. "Executive Compensation and Principal-Agent Theory," Journal of Political Economy, University of Chicago Press, vol. 102(6), pages 1175-99, December. [Downloadable!] (restricted)
  14. Scharfstein, David, 1988. "The Disciplinary Role of Takeovers," Review of Economic Studies, Blackwell Publishing, vol. 55(2), pages 185-99, April. [Downloadable!] (restricted)
  15. Bettis, J. C. & Coles, J. L. & Lemmon, M. L., 2000. "Corporate policies restricting trading by insiders," Journal of Financial Economics, Elsevier, vol. 57(2), pages 191-220, August. [Downloadable!] (restricted)
  16. Robert Gibbons & Kevin J. Murphy, 1990. "Relative performance evaluation for chief executive officers," Industrial and Labor Relations Review, ILR Review, ILR School, Cornell University, vol. 43(3), pages 30-51, February.
  17. Robert Gibbons & Kevin J. Murphy, 1992. "Optimal Incentive Contracts in the Presence of Career Concerns: Theory and Evidence," NBER Working Papers 3792, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  18. Jeffrey L. Coles & Jose Suay & Denise Woodbury, 2000. "Fund Advisor Compensation in Closed-End Funds," Journal of Finance, American Finance Association, vol. 55(3), pages 1385-1414, 06. [Downloadable!] (restricted)
  19. Jensen, Michael C & Murphy, Kevin J, 1990. "Performance Pay and Top-Management Incentives," Journal of Political Economy, University of Chicago Press, vol. 98(2), pages 225-64, April. [Downloadable!] (restricted)
    Other versions:
  20. Bizjak, John M. & Brickley, James A. & Coles, Jeffrey L., 1993. "Stock-based incentive compensation and investment behavior," Journal of Accounting and Economics, Elsevier, vol. 16(1-3), pages 349-372, April. [Downloadable!] (restricted)
  21. Bengt Holmstrom, 1982. "Moral Hazard in Teams," Bell Journal of Economics, The RAND Corporation, vol. 13(2), pages 324-340, Autumn. [Downloadable!] (restricted)
Full references

Statistics
Access and download statistics

Did you know? Authors can create their own profile with links to their works on the RePEc Author Service.

This page was last updated on 2008-8-5.

This information is provided to you by IDEAS at the Department of Economics, College of Liberal Arts and Sciences, University of Connecticut using RePEc data on a server sponsored by the Society for Economic Dynamics.