Associate Professor Nitzan Shilon’s research on executive compensation was featured in a recent post on The Harvard Law School Forum on Corporate Governance and Financial Regulation. The post discusses Professor Shilon’s working paper, Replacing Executive Equity Compensation: The Case for Cash for Long-Term Performance, available here.
In this paper, Professor Shilon reconsiders the way in which corporate executives in U.S. public firms are paid for long-term performance. He takes the provocative position that equity compensation is undesirable, and that corporate executives instead should be compensated pursuant to carefully designed cash-for-performance schemes in which the executives are rewarded in cash for achieving certain long-term performance criteria.
Following is the Abstract of Replacing Executive Equity Compensation: The Case for Cash for Long-Term Performance:
Paying top executives in equity (stock and stock options) is the most significant reform of executive compensation in our generation. It has been universally welcomed not only by firms but also by academics, investors, and policy makers. Contrary to the consensus, I argue that equity compensation is undesirable. It provides perverse incentives for managers to destroy shareholder value and behave manipulatively and recklessly. It is also an economically wasteful vehicle, and its wastefulness, which is exacerbated by agency costs and cognitive biases, significantly contributes to the immense explosion of executive compensation. Because of the inherent drawbacks of equity pay arrangements, I suggest a radical proposal: to instead use carefully designed cash-for-performance schemes in which executives are rewarded in cash for attaining certain long-term performance criteria. To facilitate this reform, I recommend implementing it systemically and placing tax and disclosure rules that are applied to equity incentive pay on a level playing field with rules that are applied to cash incentive remuneration. The reform is expected to eliminate the significant costs of equity compensation and make incentive pay more effective, transparent, cheap, and better tied to performance, while improving the limited incentive benefits generated by current equity compensation arrangements.