When CEOs get paid more in stock and options, their company’s stock returns have a tendency to be lower for the next 1-3 years, according to a study by John Wald, professor of finance.
“CEOs can reduce their firms risk if they have too much pay exposure in stocks and options, and lower risk implies lower returns,” said Wald, who has taught at UTSA since 2006.
The study, “Too Much Pay Performance Sensitivity,” appeared in the Review of Economics and Statistics this spring. Wald and his co-authors studied a large sample of firms for a 13-year period. The results noted a risk aversion effect in which CEOs mitigated firm risk in order to reduce the risk to their own wealth.
“We’ve seen the explosion in CEO pay in the last 20 years,” said Wald, who has done numerous studies on CEO compensation. “And, those increases typically come from higher stock and options packages.”
While this seems to contradict the reasons why boards of directors have structured compensation packages in this manner, Wald says that it is hard to ignore strong statistical evidence to support his case.
How to remedy this situation? Wald says that directors could focus more on cash bonuses and less on large stock and options packages to incentivize senior management.
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