Pay(out) for Performance? Evidence from Long-term Incentive Plans

Abstract

The widespread adoption of performance-contingent compensation plans increases the gap between executives’ ex-ante reported pay and final take-home pay. The common practice of evaluating executive compensation using ex-ante reported values can be misleading. We address this issue with hand-collected plan-level realized payouts from CEOs’ long-term accounting-based incentive plans. We find a significant positive relation between firm performance and payout likelihood or levels. A 0.01 increase in average ROA during the performance period corresponds to a 6.4% increase in plan payout. The payout-performance relation is not due to earnings manipulation or contract design. Shareholders react positively and increase support for Say-on-pay voting when CEOs receive payouts at or above the target level. These CEOs are also less likely to leave. However, we uncover that some firms make excessive, performance-unrelated payouts, indicating managerial rent-seeking. Our findings cannot be inferred from ex-ante reported pay targets, highlighting the importance of understanding executives’ take-home pay.

Keywords: Executive compensation payout, Actually-paid compensation, Performance plans, Accounting-based incentives, Pay for performance

JEL Classification: M12; J33; G32; M41