Companies, investors, and regulators around the world
are now seeking to tie executives' payoffs to long-term results and
avoid rewarding executives for short-term gains. Focusing on
equity-based compensation, the primary component of top executives' pay,
the authors analyze how such compensation should best be structured to
provide executives with incentives to focus on long-term value creation.

To improve the link between equity compensation and
long-term results, the authors recommend that executives be prevented
from unwinding their equity incentives for a significant time period
after vesting. At the same time, however, the authors suggest that it
would be counterproductive to require that executives hold their equity
incentives until retirement, as some have proposed. Instead, the authors
recommend that companies adopt a combination of "grant-based" and
"aggregate" limitations on the unwinding of equity incentives.

Grant-based limitations would allow executives to unwind
the equity incentives associated with a particular grant only gradually
after vesting, according to a fixed, pre-specified schedule put in
place at the time of the grant. Aggregate limitations on unwinding would
prevent an executive from unloading more than a specified fraction of
the executive's freely disposable equity incentives in any given year.

Finally, the authors emphasize the need for effective
limitations on executives' use of hedging and derivative transactions
that would weaken the connection between executive payoffs and long-term
stock values that a well-designed equity arrangement should produce.