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The Pricing of Relative Performance Based Incentives for Executive Compensation

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  • António Câmara

Abstract

Since 1995, more than 50 percent of the firms in the FTSE‐100 have granted rewards to their senior executives, the payoffs of which are contingent on the firm’s stock return relative to a bench mark return over a given period (hereafter, relative performance incentives). This paper investigates and derives closed‐form solutions for a class of relative performance incentives that have a positive payoff if, in addition to the traditional contingencies, the firm’s stock return is higher than the market return times a threshold. Results suggest that UK firms, in practice, when relative performance incentives (RPI’s) substitute absolute performance incentives (API’s) tend to (i) decrease the cost of their compensation packages; (ii) undertake more risky capital‐investment projects; and (iii) avoid providing so high‐powered incentives to increase shareholder wealth.

Suggested Citation

  • António Câmara, 2001. "The Pricing of Relative Performance Based Incentives for Executive Compensation," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 28(9‐10), pages 1115-1139, November.
    • Handle: RePEc:bla:jbfnac:v:28:y:2001:i:9-10:p:1115-1139:b
    DOI: 10.1111/1468-5957.00410
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    Cited by:

    1. Yu Flora Kuang, 2008. "Performance-vested Stock Options and Earnings Management," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 35(9-10), pages 1049-1078.
    2. Yu Flora Kuang, 2008. "Performance‐vested Stock Options and Earnings Management," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 35(9‐10), pages 1049-1078, November.
    3. Hu, Fang & Tan, Weiqiang & Xin, Qingquan & Yang, Sixian, 2013. "How do market forces affect executive compensation in Chinese state-owned enterprises?," China Economic Review, Elsevier, vol. 25(C), pages 78-87.
    4. Kuang, Y., 2007. "Incentive effects of performance-vested stock options," Other publications TiSEM 18dd1758-4773-426f-98f3-d, Tilburg University, School of Economics and Management.
    5. Chang, Chuang-Chang & Lin, Jun-Biao, 2010. "The valuation of contingent claims using alternative numerical methods," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 20(5), pages 490-508, December.

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