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CEO Pay and the Rise of Relative Performance Contracts: A Question of Governance?

Author

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  • Brian Bell
  • Simone Pedemonte
  • John Van Reenen

Abstract

Would moving to relative performance contracts improve the alignment between CEO pay and performance? To address this, we exploit the large rise in relative performance awards and the share of equity pay in the UK over the last two decades. Using hand-collected data from annual reports on explicit contracts, we find that despite these changes: (1) CEO pay still responds more to increases in the firms' stock performance than to decreases. Moreover, this asymmetry is stronger when corporate governance is weak; (2) "pay-for-luck" persists as remuneration increases with random positive shocks, even when the CEO has equity awards that explicitly condition on firm performance relative to peer firms in the same sector. We show that a major reason why explicit relative performance contracts do not eliminate pay for luck is that CEOs who fail to meet the terms of their past performance awards are able to obtain more generous new equity rewards in the future. Moreover, this is stronger when the firm has weak corporate governance. These findings suggest that reforms to the formal structure of CEO pay contracts are unlikely to align incentives in the absence of strong shareholder governance.

Suggested Citation

  • Brian Bell & Simone Pedemonte & John Van Reenen, 2016. "CEO Pay and the Rise of Relative Performance Contracts: A Question of Governance?," CEP Discussion Papers dp1439, Centre for Economic Performance, LSE.
  • Handle: RePEc:cep:cepdps:dp1439
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    References listed on IDEAS

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    Keywords

    CEO; pay; incentives; equity plans;

    JEL classification:

    • J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods
    • J31 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Wage Level and Structure; Wage Differentials
    • G30 - Financial Economics - - Corporate Finance and Governance - - - General

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