Reforming Executive Compensation: Focusing and Committing to the Long-term

This Essay offers an executive compensation reform proposal that is especially addressed to firms receiving government financial assistance and thought to pose a systemic risk, although we think that all firms should consider its adoption. Executive compensation reform should lead to policies that are simple, transparent, and focused on creating and sustaining long-term shareholder value. With these criteria in mind, we suggest that executive incentive compensation plans should consist only of restricted stock and restricted stock options, restricted in the sense that the shares cannot be sold or the option cannot be exercised for a period of at least two to four years after the executive's resignation or last day in office. We would permit a minor amount to be paid out to executives currently to address tax, liquidity, and premature turnover concerns that the proposal could induce. We believe that this approach will provide superior incentives for executives to manage corporations in investors' longer-term interest, and diminish their incentives to make public statements, manage earnings, or accept undue levels of risk, for the sake of short-term price appreciation. By reducing management's incentive to take on unwarranted risk, our proposal should therefore also decrease the threat that public resources will be wasted when a firm receives government assistance or is deemed by public officials as "too big to fail."