Most compensation packages do a poor job of linking pay to performance. Our research of pay packages at 702 publicly traded U.S. companies between 1995 and 2004 reveals that on average a 1% increase in company value generated a 0.43% increase in the estimated wealth of senior executives. That might not seem unreasonable, but there were huge variations across the sample, with executive wealth at some firms being highly sensitive to company value, while at others there was no sensitivity at all. More significant, nearly all of the incentives came from current stock and option holdings. (See the chart “Sensitivity of Executive Wealth.”) The present value of future compensation, which constitutes 75% of executive wealth, shows very little sensitivity to company value.
Why Executive Pay Is Failing
Most compensation packages do a poor job of linking pay to performance. Our research of pay packages at 702 publicly traded U.S. companies between 1995 and 2004 reveals that on average a 1% increase in company value generated a 0.43% increase in the estimated wealth of senior executives. That might not seem unreasonable, but there […]
Summary.
Reprint: F0606H
Because executive pay policies show very little sensitivity to company value, underperformers often are overpaid while top performers are underpaid.
A version of this article appeared in the June 2006 issue of Harvard Business Review.