Many studies as well as anecdotes document a link between the structure of chief executive officer (CEO) compensation and various measures of earnings manipulation. In this paper, HBS professors Oberholzer-Gee and Wulf analyze all components of compensation packages for CEOs and for managers at lower levels in a large sample of firms over more than 10 years, between 1986 and 1999. Results suggest that the effects of incentive pay on earnings management vary considerably by both type of incentive pay and position. Overall, it appears that the primary focus of compensation committees on equity incentives for CEOs overlooks a critical component in curbing earnings manipulation. If one wanted to weaken incentive pay to get more truthful reporting, diluting bonuses-particularly that of the chief financial officer (CFO)-would be the place to start. This may be the first study to analyze the relationship between CEO, division manager, and CFO compensation and earnings management.
Published in 2011
Discussions about incentives for CEOs in the United States begin, and often end, with equity-based compensation. After all, stock options and (more recently) grants of restricted stock have comprised the bulk of CEO pay since the mid-1990s, and the changes in CEO wealth due to changes in company stock prices dwarf wealth changes from any other source. Too often overlooked in the discussion, however, is the role of annual and multiyear bonus plans—based on accounting or other non-equity-based performance measures—in rewarding and directing the activities of CEOs and other executives. In this paper, Kevin J. Murphy and Michael C. Jensen describe many of the problems associated with traditional executive bonus plans, and offer suggestions for how these plans can be vastly improved. The paper includes recommendations and guidelines for improving both the governance and design of executive bonus plans and, more broadly, executive compensation policies, processes, and practices. The paper is a draft of a chapter in Jensen, Murphy, and Wruck (2012), CEO Pay and What to Do About it: Restoring Integrity to both Executive Compensation and Capital-Market Relations, forthcoming from Harvard Business School Press.
CEOs of UK firms receive higher total compensation if their companies have interactions with US product, capital, and labor markets. Moreover, the compensation package is often adopted from American-style arrangements, such as the use of incentive-based pay. Researchers Joseph J. Gerakos (University of Chicago), Joseph D. Piotroski (Stanford), and Suraj Srinivasan (Harvard Business School) analyzed data on the compensation practices of 416 publicly traded UK firms over the period 2002 to 2007.
Published in 2010
In studying pay-for-performance-based compensation systems, economic scholars often adhere to agency theory, which hypothesizes that firms should prominently use performance-based compensation—it alleviates the problems of employee "shirking" and ensures highly skilled employees' desire to work for the company. However, firms use performance-based pay far less frequently than agency theory predicts. This paper posits that the psychological costs of pay-for-performance systems often dominate their benefits to firms, and proposes an integrated theory of strategic compensation that takes into account the economic and psychological benefits and costs of pay-for-performance. Research was conducted by Harvard Business School professors Francesca Gino and Ian Larkin, and Lamar Pierce of Washington University.
The use of "non-linear" performance-based incentive contracts is very common in many business environments. The most well-known example is salesperson compensation, though many other types of performance-based pay, including stock options, bonus systems based on defined metrics, and pay based on subjective performance, often exhibit non-linear characteristics. Research has demonstrated that non-linear incentives are highly distortionary because employees manipulate their work in order to maximize their pay. While some scholars have recommended that companies stop using non-linear incentives, little research has been done to investigate the possible benefits of non-linear schemes. In this paper, HBS professor Ian Larkin and Ross School of Business professor Stephen Leider (HBS PhD '09) explore the role that the behavioral bias of overconfidence may play in explaining the prevalence of non-linear incentive schemes. They conclude that the linearity or non-linearity of an incentive system could play an important role in sorting employees according to their level of confidence; in addition, there may be three possible benefits to having overconfident employees.
Do different kinds of firm ownership drive the adoption of different managerial practices? HBS professor Raffaella Sadun and coauthors focus on the difference between the two most common ownership modes, family firms and firms that are widely held, namely that have no dominant owner. They find that the greater weight attached by family firms to benefits from control induces a conflict of interest between family-firm owners and high-ability, risk-tolerant managers.
Published in 2009
"Say on pay" legislation now under debate Washington D.C. can be a useful tool for shareholders to strengthen the link between CEO pay and performance when it comes to golden parachutes, says Harvard Business School professor Fabrizio Ferri. Here's a look at how the collective involvement of multiple stakeholders could shape the future of executive compensation.
Now that the worst fears about economic meltdown are receding, what should be done about lingering issues such as over-the-top executive compensation? Does government have a role? Is it time we rethink corporate governance? HBS faculty weigh in. From the HBS Alumni Bulletin.
There is a time and place for retention bonuses but they should be used sparingly, wrote many respondents to this month's column, says Professor Jim Heskett. Others challenged the value of bonuses, and suggested compelling alternatives. (Online forum now closed; next forum begins October 2.)
Published in 2008
(Previous title: "CEO and CFO Career Consequences to Missing Quarterly Earnings Benchmarks.") This paper investigates whether the failure to meet quarterly earnings benchmarks such as the analysts' consensus forecast matters to CEO and CFO careers, after controlling for both operating and stock return performance and the magnitude of the earnings "surprise" revealed at the earnings announcement. In particular, it evaluates a comprehensive set of career consequences such as the impact on compensation, in the form of bonus and equity grants, and the dismissal of both the CEO and the CFO, conditioned on the failure to meet quarterly earnings benchmarks.
Published in 2007
Online forum now CLOSED. Professor Jim Heskett sums up 98 reader responses from around the world. As he concludes, is there another subject as important as this one about which we assume so much and know so little?
Published in 2006
Who says you can't rewrite history? Dozens of companies have been caught in the practice of backdating options for top executives. But this is only part of the problem with C-level compensation packages, which often motivate top executives to act in their own best interests rather than those of shareholders. Professors Mihir Desai and Joshua Margolis turn to philosopher John Rawls for a solution: Reward the execs, but don't give them the details.
Compensation committees are under pressure to keep CEO pay high, even as shareholders and the media agitate for moderation. The solution? Boards of directors need better competitive information and an ear to what shareholders are saying, says Jay Lorsch.
Do CEOs deserve "star" compensation? The idea that CEO pay is driven by the invisible hand of market forces is a myth from which chief executives have long benefited, say Harvard professors Lucian Bebchuk and Rakesh Khurana.
Published in 2005
There appears to be little or no relationship between the size of American CEO compensation awards and actual corporate performance. Will change come from the increased level of competition among global companies with significantly different approaches to the compensation of senior managers?
Published in 2003
The authors review the key roles of corporate boards and recommend a Balanced Scorecard approach to help boards work smarter, not harder. Kaplan and Nagel recommend a three-part Balanced Scorecard program: Part 1: An Enterprise Scorecard that includes enterprise-wide strategic objectives, performance measures, targets, and initiatives; Part 2: A Board Scorecard that defines and clarifies the strategic contributions and requirements of the board, and provides a tool to manage the board's performance; Part 3: Executive Scorecards, which define strategic contributions of top management and are used to select, evaluate, and reward senior executives.
Published in 2002
Published in 2001
Not to mince words, but corporate budgeting is a joke, argues HBS professor emeritus Michael C. Jensen in this Harvard Business Review excerpt. The problem isn't with the budget process—it's when budget targets are used to determine compensation.
Published in 1999
