Long Term Incentive Plans, Executive Pay and UK Company Performance*

Abstract

 In agency theory, the remuneration packages of executive directors in large companies are seen as an attempt to give them a pattern of rewards that aligns their interests more closely with shareholders as a whole. The sensitivity of total executive rewards to share price performance has become the conventional yardstick for judgements concerning whether reward packages do indeed serve shareholders' interests or executives themselves.Long-term incentive plans (LTIPs) introduced in the UK from 1995 have imposed new, firm-specific performance conditions on senior managers. While LTIPs are designed to increase performance-pay sensitivity, however, they also give executives new opportunities to manipulate the terms of LTIPs in their own favour, at the expense of shareholders and stakeholders in general.This paper presents the first estimates of UK total executive rewards that include detailed LTIP valuations. It finds that, while increasing average total rewards, the presence of LTIPs is actually associated with reductions in the sensitivity of executives' total rewards to shareholder return. This raises doubts concerning both the effectiveness of the LTIP instrument and the validity of an agency perspective in this context.

The economic psychology of incentives: An international study of top managers

“…More evidence is required, but the conjecture is consistent with the phenomenon of executive pay inflation during the period that long-term incentives have come to comprise an ever greater proportion of total compensation. It is also, as we have already pointed out, consistent with the arguments based on rational choice theory and deductive logic advanced by Lambert, Larcker and Verrechia (1991), Meulbroek (2001), Hall and Murphy (2002) and Buck, Bruce, Main and Udueni (2003).…”

“…Although based on a fundamentally different logic, this is consistent with previous research by Lambert, Larcker and Verrechia (1991), Meulbroek (2001), Hall and Murphy (2002) and Buck, Bruce, Main and Udueni (2003), on which we comment further in the theory and discussion sections. The paper proceeds as follows.…”

“…In this article, we have demonstrated that the value of long-term incentives, as subjectively perceived by senior executives, is less than the economic cost to the company. We have already noted that this is not the first time that the efficiency of stock-based rewards has been questioned (Buck et al, 2003;Hall & Murphy, 2002;Lambert et al, 1991;Meulbroek, 2001). Previous arguments have assumed risk averse, non-diversified, but fully rational executives and have largely been based on the portfolio effect: rational investors seeking to balance their investment portfolio will discount disproportionate holdings of a single stock, especially when that stock is closely linked to their employment.…”

“…A number of scholars, working deductively in a rational choice framework, have argued that the cost of equity incentives will often significantly exceed the value of those incentives as calculated by risk-averse, undiversified executives who are unable to sell stock or hedge their risk (Buck et al, 2003;Hall & Murphy, 2002;Lambert et al, 1991;Meulbroek, 2001) .…”

The relationship between remuneration and financial performance for companies listed on the Johannesburg Stock Exchange

“…Pass (2003) found that most LTIPs were undemanding and rewarded average instead of outstanding performance. Buck et al (2003) concluded that LTIPs are generally associated with reductions in the sensitivity of the relationship between executives' total rewards and shareholder returns and thus questioned their effectiveness. Walker (2010) also concluded that there is an inadequate relationship between executive compensation and long-term company performance.…”