Monitoring, Contractual Incentive Pay, and the Structure of CEO Equity-Based Compensation

Abstract

I find that a CEO who is better monitored tends to have smaller total contractual incentive pay, measured by the delta of the CEO's total portfolio. The realized wealth-to-performance sensitivity (WPS) of such a CEO, however, is not significantly different from that of a CEO who is worse monitored. The findings suggest that monitoring and contractual incentives can be substitutes, rather than complements assumed by prior corporate governance research. I further study how a firm manages the total contractual incentives provided to its CEO. I find that a firm adjusts the structure of equity-based compensation, specifically, the split between restricted stock and options, to manage it. Better monitored firms tend to have higher proportions of restricted stock in the CEO's total equity-based compensation. The higher ratio is associated with lower total contractual incentives and total pay level. The findings suggest that how a board provides equity-based compensation matters.