In the Money: What Really Motivates Executive Performance?

CEO compensation has soared over the past four decades, aided by consultants, compensation committees, the CEOs themselves, and an extended bull market (1982-1999). In this report, we explore what types of compensation motivate top executives to boost shareholder returns, and the fundamental characteristics of companies in which executives are motivated to boost stock performance. Our research findings include the following:

• Despite wide acceptance of executive pay-for-performance, we find no evidence that high levels of total incentive compensation (performance-based cash plus stock and stock option awards) result in higher-than-average shareholder returns.
• We do find evidence that large stock option holdings by CEOs lead to higher-than-average shareholder returns. Large holdings imply both that the CEO is paid in options (incentive compensation) and that the CEO chooses to retain exercisable options. At the end of 2016, S&P 1500 named executives held $31.4 billion of in-the money stock options, of which nearly 80% were exercisable.
• Large stock option holdings provide a powerful motivator for CEOs to increase shareholder returns, as option value is leveraged to stock-price appreciation. They also signal CEO confidence in a company’s outlook: the willingness to accept the risk of a stock price decline in exchange for tax deferral.
• Option holdings appear to motivate executive cash deployment decisions: Companies of large option holders repurchase more shares and issue more debt than industry peers, and engage in less merger & acquisition activity. Share repurchases boost earnings per share growth, while M&A is often value destroying.
• Executive confidence, as signaled by large stock option holdings, also appears warranted: Companies where CEOs hold large options positions have higher long-term sales, earnings per share, and cash flow growth rates than industry peers, as well as better profit margin improvement. Companies where CEO option holdings are low have below-average readings on these metrics.