CEO Incentives can boost short-term stock price but destroy long-term value, according to the two winning academic papers of the Investor Responsibility Research Center Institute (IRRCi) annual investor research competition. The winning academic research teams share a $10,000 award.
According to Jon Lukomnik, IRRCi Executive Director.
The two winning research papers use the vesting schedule for CEO compensation – when the CEO can sell stocks and options – to demonstrate that heavy vesting periods lead to actions that suggest that some CEOs are more concerned with short-term stock price movement than long-term value creation. These are the first papers to closely examine the structure of CEO equity vesting schedules and then correlate it to value-creating or value-destroying corporate activities.
For example, the research finds that a high amount of equity vesting will increase the likelihood that a company will revise guidance upward; reduce research and development and capital expenditures; buy-back shares or increase the amount of its share buy-back; and even enter into merger and acquisition activity. The research paints a clear and bold portrait of short-termism with concern for long-term value creation faded into the background.
The first winning research paper on CEO incentives, Equity Vesting and Investment, is co-authored by Alex Edmans, London Business School; Vivian Fang, Carlson School of Management at the University of Minnesota; and Katharina A. Lewellen, Tuck School of Business at Dartmouth.
This paper studies the link between real investment decisions and CEO’s short-term stock price concerns. It finds that vesting equity induces CEOs to reduce investments in long-term projects and to take actions that increase short-term stock price. More broadly, it shows that that the structure of CEO compensation has a causal effect on real-world decisions.
Alex Edmans said,
We are honored to win this award. With IRRC’s leading role in the practice of corporate governance, we hope our research can be used to guide the reform of executive pay. While pay does need to be improved, a correct diagnosis must precede treatment. Many views on executive pay – and thus calls for reform – are based on hand-picked anecdotes rather than large-scale evidence. While reformers often target the level of pay, our research suggests that the horizon of pay is a more important dimension. Giving CEOs equity with long vesting periods will encourage them to focus on long-term investment rather than short-term earnings.
Vivian Fang said,
For decades, both academics and practitioners have argued that short-term incentives hinder long-term growth. While intuitive, showing a causal effect of incentives on CEO actions is challenging because the same factors that drive CEO actions can also drive incentives. We use CEO vesting schedules – which were decided several years prior and thus are unlikely linked to current CEO actions – as a measure of short-term incentives. By linking vesting equity to firm outcomes that reflect value erosion, we show a negative causal effect of short-term incentives on firm value.
The second winning paper on CEO incentives, The Long-Term Consequences of Short-Term Incentives, is also co-authored by Edmans and Fang, together with Allen H. Huangof the Hong Kong University of Science and Technology. This paper studies two corporate actions that allow accurate measurement of the long-term consequences of short-term incentives – stock repurchases and mergers and acquisitions (M&A).
The research shows that the impending vesting of equity may lead CEOs to take myopic actions that boost the short-term stock price at the expense of long-term value. An increase in vesting equity is associated with a greater frequency of stock repurchases and M&A announcements, and both corporate events were associated with higher short-term returns and lower long-term returns.
The academic paper submissions were of such high quality that the judges selected another research paper on CEO incentives for Honorable Mention recognition, Corporate Governance and The Rise of Integrating Corporate Social Responsibility Criteria in Executive Compensation: Effectiveness and Implications for Firm Outcomes. This research is co-authored by Caroline Flammer at Boston University’s Questrom School of Business; Bryan Hong at the University of Western Ontario’s Ivey Business School; and Dylan Minorat Northwestern University’s Kellogg School of Management. This study finds that the integration of corporate social responsibility criteria in CEO incentives – a relatively recent phenomenon – leads to an increase in long-term orientation; an increase in firm value; an increase in social and environmental performance; a reduction in emissions; and an increase in green innovations.
The respected judges for the 2017 IRRC Institute Prize were:
- Robert Dannhauser, Head of Capital Markets Policy, CFA Institute
- James Hawley, Professor emeritus and Director of the Elfenworks Center for Fiduciary Capitalism at St. Mary’s College of California
- Erika Karp, Founder, CEO and Chair of the Board of Cornerstone Capital
- Nell Minow, Governance Expert and Huffington Post Columnist
The Investor Responsibility Research Center Institute is a nonprofit research organization that funds academic and practitioner research enabling investors, policymakers, and other stakeholders to make data-driven decisions. IRRCi research covers a wide range of topics of interest to investors, is objective, unbiased, and disseminated widely.