Recent Trends in Executive Compensation: Are They Pareto Improving?

In recent years firms have been shifting their executive compensation packages from plain stock and option grants to grants with accounting-based performance vesting provisions and awards that benchmark firm performance against those of a designated peer group. One potential explanation for this trend is that firms want to improve the signal-noise ratio of performance measures. This paper directly tests this hypothesis. It estimates the statistical relationship between various performance measures and computes the optimal combination of awards. It finds that the observed trend is consistent with compensation optimization. It also finds that firms with higher potential gains from switching to alternative performance characteristics have increased their usage more than other firms.