Closer Look Series: Topics, Issues and Controversies in Corporate Governance, No. CGRP-10, By David F. Larcker, James Irvin Miller Professor of Accounting, Director of Stanford Graduate School of Business Corporate Governance Research Program And Brian Tayan, MBA ’03, Stanford GSB; Date: 9-15-2010
In recent years, there has been considerable debate as to whether CEO compensation is actually correlated with performance in U.S. companies. This issue is known as “pay for performance.” While the debate is often heated, there tends to be little in the way of concrete analysis to inform conclusions.
We explain an important new method for measuring pay for performance. This involves examining the sensitivity of CEO equity ownership to potential large-scale changes in the stock price. We explain how the convexity of this relationship can give shareholders and stakeholders a better understanding of the incentives that the company is offering to its CEO. We also explain that it is important to review this information in the context of the company’s strategy to determine whether potential payments are appropriate and whether they encourage “excessive” risk taking.