Too Much Is Not Enough: Incentives in Executive Compensation

By Robert W. Kolb | Go to book overview

9
Incentives in Executive Compensation:
A Final Assessment

Incentive Compensation and the Level of Executive Pay

From 2000 to 2009, average CEO compensation at S&P 500 firms fell by 36 percent from a peak of $15 million to $9.6 million. But pay rose from 2009 to 2010 by almost 19 percent, to an average of $11.4 million. Whether compensation will continue to rise is unclear, but it is certain to maintain quite high levels, especially when measured against the incomes of ordinary workers. In recent years, equity-related pay has stayed relatively constant, constituting about 52–54 percent of total compensation. However, 2010 saw a significant drop in the proportion of pay delivered in the form of ESOs, dropping from 29.83 to 18.93 percent of total pay in just one year. This shift from ESOs to restricted stock represents an important change, one that some will regard as extremely beneficial, but one with disturbing implications as well.

Firms set incentives for their top management teams mainly by granting them equity-related compensation. Between ESOs and restricted stock, ESOs far and away are the more highly incentivizing form of compensation, while large holdings of restricted stock encourage conservatism and may well frustrate the risk-taking entrepreneurialism necessary to create corporate profits and societal wealth. Thus, the shift away from ESOs and toward restricted stock, while holding equity-based compensation as a constant proportion of total pay, implies a substantial weakening of CEO incentives. If we consider the financial sector alone with its critical systemic role and explicit and implicit governmental guarantees, this reduction in incentives may well be socially beneficial. However, for firms in other industries, reducing incentives to take risks and create new products will likely stymie innovation and retard economic growth and employment. At a time when the United States faces intensifying challenges from abroad, this is a disturbing development, particularly if it is the leading edge of a persistent trend.

As we have also seen, compensation through ESOs is an inefficient form of pay, costing the firm more than the value the CEO actually receives. If we were to hold the total pay package of a CEO constant, and shift the mix

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