What Investors Need to Know about Executive Pay

Abstract

Public company disclosures give analysts a comprehensive measure of top management’s total compensation but do not provide a comprehensive measure of management’s incentive to increase shareholder value. This article presents comprehensive measures of management’s value and growth incentives. The authors’ incentive measures (“value wealth leverage” and “revenue wealth leverage”) show the sensitivity of management wealth to changes in shareholder wealth and revenue. The article shows how investors can use these measures to determine whether top management has a strong value-creation incentive, a strong incentive to pursue value-destroying growth, or neither. The authors also present findings from their study of S&P 1500 companies, including an analysis of the impact of value wealth leverage on subsequent shareholder returns. The results show that companies with high value wealth leverage tend to outperform other firms in terms of excess returns, but the effects are concentrated among value (as opposed to growth) firms.

TOPICS: Manager selection, legal/regulatory/public policy, statistical methods