RESEARCH: Evolving Executive Equity Compensation and the Limits of Optimal Contracting -

David I. Walker

Boston University School of Law; New York University School of
Law





August
1, 2009


Boston University School of Law Working Paper No.
09-34
NYU Law and Economics Research Paper No. 09-46

Abstract:

    



Executive equity compensation in the U.S. is evolving. At the turn of
the millennium, stock options dominated the equity pay landscape,
accounting for over half of the aggregate ex ante value of senior
executive pay at large public companies, while restricted stock and
similar compensation accounted for only about ten percent. Beginning in
2006, stock grants have displaced options as the single largest
component of senior executive compensation at these firms. Accompanying
this shift has been increased variation among companies in their
relative emphasis on stock and options in equity pay packages. Both
phenomena provide an opportunity for a rich exploration of executive pay
contracting focusing specifically on equity pay design. Such an
exploration is timely given the current focus in Washington on the
relationship between equity compensation and corporate risk taking. This
article begins that exploration and has two primary aims. First, it
describes the evolution in executive equity pay practices and the
current equity compensation landscape. Second, it considers the extent
to which this evolution and the current use of stock and option pay can
be explained as a function of efficient contracting (and what 'efficient
contracting' means in this context). The analysis reveals several
features of the executive equity pay landscape that suggest limitations
on efficient compensation contracting. First, although directionally
consistent with changes in the conventional economic determinants of
equity pay design, the dramatic shift over the last decade from very
heavy reliance on options to a more balanced emphasis on stock and
options suggests that option expensing, option taint, and/or increased
perceived option risk played leading roles. Second, the tri-modal
distribution of the mix of stock and options being granted in recent
years suggests that optimizing incentives is not the sole consideration
of issuing firms. Third, the extent to which the same mix of stock and
options is granted to the various member of the executive suite suggests
that individual optimization is quite limited.

Keywords:
executive compensation, stock options, restricted stock, optimal
contracting, managerial power

JEL
Classifications: G34, J33, K22, M52