Investor Reactions to Executive Performance Metric Design

ABSTRACT Firms must disclose the performance metrics used to determine executive compensation and whether these metrics are chosen before or after a performance period. We investigate investor reactions to these disclosures and whether investors’ reactions reflect their belief in executives’ ability to influence their pay. Despite board concerns to the contrary, we find that investors do not always punish a firm for using ex post compensation discretion rather than ex ante targets to determine executive compensation. Instead, investors are indifferent to the timing of choosing performance metrics when the metrics are more objective. Also, investors are not opposed to the use of more subjective metrics, provided they are chosen before the performance period. Thus, deviations from executive compensation norms may receive more leniency from investors provided boards attend to the conditions in which each type of contract is likely to be viewed by investors as evidence of managerial rent extraction. Data Availability: Data are available from the authors upon request. JEL Classifications: G40; M41.