Too Much Is Not Enough: Incentives in Executive Compensation (Financial Management Association Survey and Synthesis)

The scholarly literature on executive compensation is vast. As such, this literature provides an unparalleled resource for studying the interaction between the setting of incentives (or the attempted setting of incentives) and the behavior that is actually adduced. From this literature, there are several reasons for believing that one can set incentives in executive compensation with a high rate of success in guiding CEO behavior, and one might expect CEO compensation to be a textbook example of the successful use of incentives. Also, as executive compensation has been studied intensively in the academic literature, we might also expect the success of incentive compensation to be well-documented. Historically, however, this has been very far from the case.In __Too Much Is Not Enough__, Robert W. Kolb studies the performance of incentives in executive compensation across many dimensions of CEO performance. The book begins with an overview of incentives and unintended consequences. Then it focuses on the theory of incentives as applied to compensation generally, and as applied to executive compensation particularly. Subsequent chapters explore different facets of executive compensation and assess the evidence on how well incentive compensation performs in each arena. The book concludes with a final chapter that provides an overall assessment of the value of incentives in guiding executive behavior. In it, Kolb argues that incentive compensation for executives is so problematic and so prone to error that the social value of giving huge incentive compensation packages is likely to be negative on balance. In focusing on incentives, the book provides a much sought-after resource, for while there are a number of books on executive compensation, none focuses specifically on incentives. Given the recent fervor over executive compensation, this unique but logical perspective will garner much interest. And while the literature being considered and evaluated is technical, the book is written in a non-mathematical way accessible to any college-educated reader. Cover 1 Contents 8 Preface 10 1. The Magnitude and Structure of Executive Compensation 16 The Magnitude of CEO Compensation 17 The Structure of Executive Compensation 26 Salary 27 Bonuses and Long-Term Incentive Plans 29 Restricted Stock Awards 31 Executive Stock Option (ESO) Awards 32 Other Forms of Compensation 34 2. Corporate Governance, Agency Problems, and Executive Compensation 39 Corporate Governance 39 Agency Theory and Incentive Alignment 42 Corporate Governance, Incentive Alignment, and the Managerial Power Hypothesis 47 The Levers of Managerial Power 48 Limits to Pay in the Managerial Power Hypothesis 50 Assessing the Conceptual Conflict Between the Agency-Theoretic and Managerial Power Views of Executive Compensation 51 What About Ethics, Duty, and Justice? 54 Fiduciary Duty 56 Executive Compensation and Distributive Justice 56 3. The Incentive Structure of Executive Compensation 60 The Incentive Revolution and Executive Compensation 60 Salary 63 Bonuses 64 Restricted Stock and Performance Shares 68 Executive Stock Options 71 Equity Compensation: Retaining the Employees You Have and Attracting the Ones You Want 77 Different Instruments as Tools of Incentive Compensation 79 4. Executive Stock Options and the Incentives They Create 81 ESO Incentives, Firm Practices, and the Effect of Accounting Rules 81 Option Pricing Models 84 Option Valuation Effects of Individual Option Parameters 85 The Option Pricing Model and Incentives 89 Executive Stock Option Design, Management, and Incentives 92 What Exercise Price? 94 Repricing and Reloading Executive Stock Options 96 The CEO’s Utility and the Desire for ESOs 100 5. Executive Stock Option Programs: The Behavior of CEOs, Firms, and Investors 104 CEO Wealth, Pay, and Performance 104 Exercise of ESOs 110 Unwinding Incentives 116 6. Executive Incentives and Risk Taking 119 Equity Compensation and the CEO’s Risk Appetite 124 Executive Compensation and the Risk-Taking Behavior of CEOs 128 Incentive Compensation, Risk Taking, and the Financial Crisis of 2007–2009 133 7. Incentive Compensation and the Management of the Firm 136 Incentive Compensation and the Firm’s Investment Program 137 CEO Incentives and the Firm’s Financing Decisions 140 Compensation Incentives, Dividends, and Share Repurchases 144 Corporate Mergers, Acquisitions, and Liquidations 146 Compensation Incentives and Corporate Risk Management 149 Compensation Incentives and Corporate Disclosures 152 8. Perverse Incentive Effects: Executives Behaving Badly 155 Earnings Management 156 Option Games and Exploitation 162 Option Games: A Warning About Incentives in Executive Compensation 168 9. Incentives in Executive Compensation: A Final Assessment 170 Incentive Compensation and the Level of Executive Pay 170 New Legislation and the Shaping of Incentives 171 How Dysfunctional Is Executive Pay? 173 On Balance, Is Incentive Compensation Beneficial? 174 To Improve Executive Compensation, Improve Corporate Governance 175 Executive Pay, Continuing Inequality, and the Question of Justice 177 Appendix 178 Notes 182 Bibliography 208 Index 224 A 224 B 224 C 225 D 226 E 226 F 227 G 227 H 228 I 228 J 228 K 228 L 228 M 229 N 229 O 229 P 229 R 230 S 230 T 231 U 231 V 231 W 231 X 231 Y 231 Content: Preface 1. The Magnitude and Structure of Executive Compensation The Magnitude of CEO Compensation The Structure of Executive Compensation Salary Bonuses and Long-Term Incentive Plans Restricted Stock Awards Executive Stock Option (ESO) Awards Other Forms of Compensation 2. Corporate Governance, Agency Problems, and Executive Compensation Corporate Governance Agency Theory and Incentive Alignment Corporate Governance, Incentive Alignment, and the Managerial Power Hypothesis The Levers of Managerial Power Limits to Pay on the Managerial Power Hypothesis Assessing the Conceptual Conflict Between the Agency-Theoretic and Managerial Power Views of Executive Compensation What about Ethics, Duty, and Justice? Fiduciary Duty Executive Compensation and Distributive Justice 3. The Incentive Structure of Executive Compensation The Incentive Revolution and Executive Compensation Salary Bonuses Restricted Stock and Performance Shares Executive Stock Options Equity Compensation: Retaining the Employees You Have, and Attracting the Ones You Want Different Instruments as Tools of Incentive Compensation 4. Executive Stock Options and the Incentives They Create ESO Incentives, Firm Practices, and the Effect of Accounting Rules Option Pricing Models Option Valuation Effects of Individual Option Parameters The Option Pricing Model and Incentives Executive Stock Option Design, Management, and Incentives What Exercise Price? Repricing and Reloading Executive Stock Options The CEO's Utility and the Desire for ESOs 5. Executive Stock Option Programs: The Behavior of CEOs, Firms, and Investors CEO Wealth, Pay, and Performance Exercise of ESOs BOX 1: Detecting Abnormal Stock Market Performance Unwinding Incentives 6. Executive Incentives and Risk-Taking Equity Compensation and the CEO's Risk Appetite Executive Compensation and the Risk-Taking Behavior of CEOs Incentive Compensation, Risk-Taking, and the Financial Crisis of 2007-2009 7. Incentive Compensation and the Management of the Firm Incentive Compensation and the Firm's Investment Program CEO Incentives and the Firm's Financing Decisions Compensation Incentives, Dividends, and Share Repurchases, Corporate Mergers, Acquisitions, and Liquidations Compensation Incentives and Corporate Risk Management Compensation Incentives and Corporate Disclosures 8. Perverse Incentive Effects: Executives Behaving Badly Earnings Management Option Games and Exploitation Option Games: A Warning About Incentives in Executive Compensation 9. Incentives in Executive Compensation: A Final Assessment Incentive Compensation and the Level of Executive Pay New Legislation and the Shaping of Incentives How Dysfunctional is Executive Pay? On Balance, Is Incentive Compensation Beneficial? To Improve Executive Compensation, Improve Corporate Governance Executive Pay, Continuing Inequality, and the Question of Justice Appendix: Binomial Valuation Method for Executive Stock Options Notes References Index "The scholarly literature on executive compensation is vast. As such, this literature provides an unparalleled resource for studying the interaction between the setting of incentives (or the attempted setting of incentives) and the behavior that is actually adduced. From this literature, there are several reasons for believing that one can set incentives in executive compensation with a high rate of success in guiding CEO behavior, and one might expect CEO compensation to be a textbook example of the successful use of incentives. Also, as executive compensation has been studied intensively in the academic literature, we might also expect the success of incentive compensation to be well-documented. Historically, however, this has been very far from the case. In Too Much Is Not Enough, Robert W. Kolb studies the performance of incentives in executive compensation across many dimensions of CEO performance. The book begins with an overview of incentives and unintended consequences. Then it focuses on the theory of incentives as applied to compensation generally, and as applied to executive compensation particularly. Subsequent chapters explore different facets of executive compensation and assess the evidence on how well incentive compensation performs in each arena. The book concludes with a final chapter that provides an overall assessment of the value of incentives in guiding executive behavior. In it, Kolb argues that incentive compensation for executives is so problematic and so prone to error that the social value of giving huge incentive compensation packages is likely to be negative on balance. In focusing on incentives, the book provides a much sought-after resource, for while there are a number of books on executive compensation, none focuses specifically on incentives. Given the recent fervor over executive compensation, this unique but logical perspective will garner much interest. And while the literature being considered and evaluated is technical, the book is written in a non-mathematical way accessible to any college-educated reader."--Publisher's website This volume studies the performance of incentives in executive compensation across many dimensions of CEO performance. It begins with an overview of incentives and unintended consequences. Then it focuses on the theory of incentives as applied to compensation generally, and as applied to executive compensation particularly. Subsequent chapters explore different facets of executive compensation and assess the evidence on how well incentive compensation performs in each arena. It concludes with overall assessment of the value of incentives in guiding executive behaviour