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

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  • Bell, Brian
  • Van Reenen, John

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 new employer-employee matched datasets we find that the CEO pay-performance relationship remains asymmetric: pay responds more to increases in shareholders' return performance than to decreases. Further, this asymmetry is stronger when governance appears weak. Second, there is substantial 'pay-for-luck' 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. A reason why relative performance pay fails to deal with 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 'compensation effect' 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

  • Bell, Brian & Van Reenen, John, 2016. "CEO Pay and the Rise of Relative Performance Contracts: A Question of Governance?," CEPR Discussion Papers 11385, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:11385
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    Cited by:

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    3. Clement Olalekan Olaniyi & Olaolu Richard Olayeni, 0. "A new perspective into the relationship between CEO pay and firm performance: evidence from Nigeria’s listed firms," Journal of Social and Economic Development, Springer;Institute for Social and Economic Change, vol. 0, pages 1-28.
    4. Janke, Katharina & Propper, Carol & Sadun, Raffaella, 2019. "The Impact of CEOs in the Public Sector: Evidence from the English NHS," CEPR Discussion Papers 13726, C.E.P.R. Discussion Papers.

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    More about this item

    Keywords

    CEO; equity plans; incentives; Pay;
    All these keywords.

    JEL classification:

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

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