Pay does make a difference to long term returns – recent research on patterns of pay, ownership and shareholder returns
21/05/2013
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In prior articles Guerdon Associates has examined the relationship between “short-termism”, executive tenure (see HERE)  and executive remuneration (see HERE).  We have also reported on “short-termism” and the impact of institutional investor ownership and executive pay (see, for example HERE and HERE

A well-researched paper provides further evidence that the structure of executive pay, as well as the investor expectations, can have consequences detrimental to the longer-term returns that could otherwise be achieved. The authors of the paper were recently announced as the winners of the Global Challenge for Innovation in Corporate Governance by sponsors BlackRock and the US National Association of Corporate Directors (NACD).

Prior research had shown that managers in publicly traded companies facing earnings pressure – the pressure to meet or beat stock analysts’ earnings forecasts – may behave in ways to improve short-term earnings. Some researchers have argued that these improvements may come from inter-temporal trade-offs that endanger future competitiveness and performance.

In the new paper, the authors Yu Zhang, assistant professor of strategy at The Paul Merage School of Business at the University of California, Irvine, and Javier Gimeno, professor of strategy at INSEAD in France, explore how important dimensions of corporate governance may intensify or mitigate how managers respond to the pressure generated by analysts’ forecasts. The dimensions include ownership structure and CEO incentives that affect the time horizons of shareholders and managers.

Using data on competitive decisions by U.S. airlines under quarterly earnings pressure, Zhang and Gimeno examine the effect of earnings pressure on competitive behavior under different corporate governance conditions. The results suggest that companies with long-term-oriented investors and long-term-aligned, unvested CEO incentives (restricted shares and exercisable stock options) are less sensitive to earnings pressure. In contrast, companies with more “transient” investors and CEOs with vested, immediately exercisable stock-based incentives are more responsive to earnings pressure.

These results are consistent with the view that earnings pressure leads managers to focus on short-term behavior that may damage longer term competitiveness and performance of their firms. This research shows how corporate governance affects competitiveness and long-term performance by shaping managers’ competing inter-temporal trade-offs and identifies ways that shareholders and board members could mitigate the short-termism often associated with earnings pressure.

The paper is titled “Earnings Pressure and Long-Term Corporate Governance: Can Long-Term-Oriented Investors and Managers Fend off Short-Term Analyst Earnings Pressures?” and can be sourced from BlackRock.

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