This Article identifies a cost to public investors of tying executive pay to the future value of a firm’s stock - even its long-term value. In particular, such an arrangement can incentivize executives to engage in share repurchases (when the current stock price is low) and equity issuances (when the current stock price is high) that reduce “aggregate shareholder value,” the amount of value flowing to all the firm’s shareholders over time. The Article also puts forward a mechanism that ties executive pay to aggregate shareholder value and thereby eliminates the identified distortions.
(University of Iowa, College of Law, 2011) Fried, Jesse; Shilon, Nitzan
We explain why firms should have a policy requiring directors to recover “excess pay” – payouts to executives resulting from an error in compensation metrics (such as inflated earnings). We then analyze the clawback policies voluntarily adopted by S&P 500 firms as of 2010 and find that only a small fraction had such a policy. Our findings suggest that the Dodd-Frank Act, which requires firms to adopt a clawback policy for certain types of excess pay, will improve compensation arrangements at most firms. We also suggest how the types of excess pay not reached by Dodd-Frank should be addressed.
