The Executive Compensation Controversy - Fondazione Rodolfo ...

More documents

Recommendations

Info

THE EXECUTIVE COMPENSATION CONTROVERSY: 24 MAY 2010A TRANSATLANTIC ANALYSISOne on hand, our results are intuitive: we know that stock and options are riskier thansalaries (and likely riskier than bonuses), and it is inappropriate to simply add the differentforms of compensation to get a measure of total compensation without regard to risk. Wealso know that executives value stock and options much less than their expected value,suggesting that stock and options should be weighted less than salaries in constructing ameasure of the value of total compensation from the perspective of a risk-averse executive.On the other hand, including the ratio of equity pay to total pay as an explanatory variable isat best a crude way to control for the riskiness of the pay package. Moreover, under plausiblesituations, this ratio may vary mechanically with total compensation for reasons havingnothing to do with risk. 92Conceptually, a better way to evaluate whether risk and pay-composition issues explainthe USA Pay Premium is to compute “certainty equivalent” measures of total compensationas outlined in Section 2.2.2. Constructing these measures require detailed data on stock andoption holdings, and require assumptions about executive risk aversion, outside wealth andtrading behavior (e.g., whether the executive adjusts his current portfolio after receivingmore options, and whether he sells shares acquired through option exercises immediatelyafter exercise). In the spirit of this approach, Conyon, Core and Guay (2009) show that, for areasonable range of parameters, the risk-adjusted pay for USA CEOs is not dramaticallyhigher than the risk-adjusted pay for UK CEOs.3.4. Equity-based Incentives for European CEOsOur finding that the observed USA Pay Premium is in part “explained” by the fact thatUSA CEOs have different pay structures merely shifts the question: Why do Americanexecutives USA receive more incentive compensation (and particularly more equity-basedcompensation) than do European executives?Indeed, while equity-based compensation (and especially stock options) has been astaple of USA compensation contracts for more than a half-century, the use of equity-basedpay in most of Europe is a relatively recent phenomenon. Table 3.10 shows how theimportance of equity-based pay has changed over time in the United States and in nineEuropean countries using Towers Perrin’s Worldwide Total Remuneration (WWTR) surveys92 For example, suppose that compensation consists solely of base salaries and stock, and that base salariesare implicitly capped, either through tax policies (Section 2.4.3) or Bebchuk-Fried “outrage” considerations(Section 2.5.1). In this case, note that Total Pay = (Capped Salary)/(1 - Ratio of Equity/Total Pay); total pay isperfectly predicted by the ratio of equity to total pay.-81-
THE EXECUTIVE COMPENSATION CONTROVERSY: 24 MAY 2010A TRANSATLANTIC ANALYSISTable 3.10 Stock-Based Pay (as a Percentage of Total Pay) in Europe and the US, based on TowersPerrin consultant surveys 1984 - 20031984 1988 1992 1996 1999 2001 2003Belgium 0.0% 0.0% 0.0% 0.0% 3.2% 11.6% 11.2%France 12.3% 13.3% 15.6% 14.6% 14.3% 15.1% 16.0%Germany 0.0% 0.0% 0.0% 0.0% 9.7% 13.5% 18.0%Italy 0.0% 0.0% 0.5% 4.0% 9.1% 17.2% 15.1%Netherlands 0.0% 0.0% 0.0% 0.0% 14.6% 16.7% 15.8%Spain 0.0% 0.0% 0.0% 0.0% 16.0% 17.9% 19.2%Sweden 0.0% 0.0% 0.0% 0.0% 6.8% 11.0% 10.7%Switzerland 1.9% 1.9% 3.4% 3.6% 1.8% 0.0% 19.2%United Kingdom 14.5% 14.6% 15.7% 15.0% 16.6% 19.1% 20.8%United States 16.9% 28.3% 32.3% 28.7% 25.5% 44.8% 48.3%Note: Data from Perrin’s Worldwide Total Remuneration reports (various issues), including 1984-1992 data reported byAbowd and Kaplan (1999). Data reflects Towers Perrin’s estimate of competitive CEO pay for industrial companieswith approximately US $300 million in annual revenues. Stock-based pay includes the grant-date expected value ofoption grants and annualized targets from performance share plans.for the selected years 1984, 1988, 1992, 1996, 1999, 2001, and 2003. <strong>The</strong> data for the years1992 to 1996 are based on the Abowd and Kaplan (1999) analysis of the WWTR surveys. Asshown in Table 3.10, only France and the UK made extensive use of stock or options in the1980s, and equity-based pay did not become common across Europe until the end of the1990s. By 2003, Towers Perrin reports that equity-based pay accounts for between 10% and20% of competitive pay for European CEOs, and for about half of pay for American CEOs.As we discussed above in Section 3.2, the percentages in Table 3.10 are not based on“data” per se, but rather depict the consulting company’s estimates of “typical” or“competitive” pay for a representative CEO in an industrial company with an assumedamount in annual revenues, based on questionnaires sent to consultants in each country. InTable 3.11, we provide our own estimates of equity-based pay for 2003-2008 based on actualgrant-date values extracted from BoardEx (for Europe) and ExecuComp (for the USA). <strong>The</strong>actual averages for 2003 in Table 3.11 are generally consistent with the consultant surveys inTable 3.10 for the same year, increasing our confidence in both data sources.As shown in Table 3.11, the use of equity-based compensation has generally declinedin continental Europe between 2003 and 2008, and has remained relatively constant in the-82-
Page 2:
1. INTRODUCTION 12. A PRIMER ON EXE
Page 5 and 6:
THE EXECUTIVE COMPENSATION CONTROVE
Page 7 and 8:
Page 9 and 10:
Page 11 and 12:
Page 13 and 14:
Page 15 and 16:
Page 17 and 18:
Page 19 and 20:
Page 21 and 22:
Page 23 and 24:
Page 25 and 26:
Page 27 and 28:
Page 29 and 30:
Page 31 and 32:
Page 33 and 34: THE EXECUTIVE COMPENSATION CONTROVE
Page 83: THE EXECUTIVE COMPENSATION CONTROVE
Page 135 and 136:
Page 137 and 138:
Page 139 and 140:
Page 141 and 142:
show all

The Executive Compensation Controversy - Fondazione Rodolfo ...

Create successful ePaper yourself

Delete template?

Save as template?