Performance horizons in CEO equity compensation: Theory and evidence

• In Event: Management Accounting 2

Abstract

This paper examines the performance horizon in CEO equity compensation. Based on a stylized sorting model, we predict that performance horizons increase with CEO’s experience and the cost of measuring performance, and decrease with the value of CEO’s alternative employment. We then test these predictions in a sample of S&P 500 industrial firms granting performance shares to CEOs. Consistent with our predictions, the results show that firms set short performance horizons for inexperienced CEOs and CEOs with valuable alternative employments, but use long horizons when measurement costs are high, indicated by intense investments and high growth potentials. We further find evidence that underperforming CEOs are more likely to depart under short horizons, supporting the notion of sorting. The horizon determinants are robust after we take into account firms’ choice of granting performance shares and the influence of compensation consultants.

Authors

• Zhan Gao, Lancaster University

• Yuhchang Hwang, Arizona State University - Tempe

• Wan-ting Wu, University of Massachusetts-Boston