Abstract/Summary

This article analyses factors influencing the choice of performance measure in CEO equity-based compensation, for a sample of 3,400 plans from 400 UK firms between 2007 and 2015. We examine the effect of the volatility of earnings per share (EPS) and of total shareholder returns (TSR) on the choice of performance measures, taking into account four categories of measure: EPS alone, TSR alone, EPS and TSR jointly, or neither EPS nor TSR. This allows us to utilize a comprehensive cross-section of plans. The results are robust to controlling for plan types, the use of different compensation consultants, industry and time-specific effects. We find that “EPS and TSR jointly” is the most common category of performance measure employed by firms. Our empirical results show that firms with higher EPS volatility and lower TSR volatility are more likely to choose TSR as a performance measure and that firms with higher EPS volatility are less likely to choose EPS alone; we argue that these results are consistent with optimal contracting theory. Second, we conduct a novel, detailed description of the performance measures, comparator groups, plan choices, threshold targets and vesting levels at minimum and maximum thresholds, used in CEO compensation contracts. We further argue that commonalities across firms in the elements of target-setting are evidence of institutional isomorphism.