NCPA - National Center for Policy Analysis

Management Compensation Encourages Corporate Performance

January 4, 1999

Although there are many reasons for the market's spectacular performance, one that has been understated is the shift in compensation of corporate management.

Ways in which executives fail to manage for the benefit of corporations' owners are legion. They may turn down potential takeovers that would benefit shareholders but threaten their positions, they may engage in ill-considered takeovers themselves solely to enhance their power and influence, they may retain too much of the corporation's profits rather than paying them out as dividends, and, of course, compensate themselves excessively.

But in the 1980s, corporate boards began to shift more and more compensation for top managers from salaries to stock options. This led to a vast increase in executive compensation. According to the Economic Strategy Institute, between 1978 and 1995 the ratio of Chief Executive Officer (CEO) pay to that of average workers roughly tripled from 60 times to 172 times. This led to many calls to reduce executive pay in the early 1990s.

What ended such complaints was the realization that as stock options increased as a share of executive compensation, CEOs worked harder to raise their companies' stock prices. The result was that the incentives and interests of owners and workers were now joined more closely together. The result has been a win-win situation for shareholders everywhere.

Source: Bruce Bartlett, senior fellow, National Center for Policy Analysis, January 4, 1999.

 

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