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| Author: | Garvey, G.T. Milbourn, T.T. |
| Title: | Asymmetric benchmarking in compensation: executives are rewarded for good luck but not penalized for bad |
| Journal: | Journal of Financial Economics
2006 : OCT, VOL. 82;1, p. 197-225 |
| Index terms: | benchmarking chief executive officers compensation |
| Language: | eng |
| Abstract: | Principal-agent theory suggests that a manager should be paid relative to a benchmark that removes the effect of market or sector performance on the company's own performance. Recently, it has been argued that such indexation is not observed in the data since executives can set pay in their own interests: that is, they can enjoy "pay for luck" as well as "pay for performance". It is first shown that this argument is incomplete. The positive expected return on stock markets reflects compensation for bearing systematic risk. If executives' pay is tied to market movements, they can only expect to receive the market-determined return for risk-bearing. This argument, however, assumes that executive pay is tied to bad luck as well as to good luck. If executives can truly influence the setting of their pay, they will seek to have their performance benchmarked only when it is in their interest, namely, when the benchmark has fallen. Using industry benchmarks, the study finds significantly less pay for luck when luck is down than when it is up. |
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