This recent study from B-school professors at UT Dallas, Berkeley, UNC and China Europe International Business School examines whether CEO equity pay motivates fraud. In short, there’s a strong correlation with earnings management within the confines of GAAP, but fraud only tends to arise when company performance is looking desperate. Here’s the abstract:
Although CEO equity incentives are commonly believed to be positively associated with accounting manipulation, the empirical evidence is mixed (Armstrong, Jagolinzer, and Larcker 2010; Edmans, Gabaix, and Jenter 2017). We revisit this relation by first recognizing that accounting manipulation ranges from permissible interpretation of GAAP to outright fraud.
While equity incentives motivate CEOs to present more favorable performance through accrual earnings management, they do not inherently lead to fraud, largely because of the substantially higher costs of fraudulent behavior. Instead, fraud arises when CEOs face heightened pressure, such as prolonged poor performance. The positive relation between equity incentives and fraud emerges only under these conditions and is concentrated when equity incentives are excessive.
We thus reestablish the positive relation between equity incentives and accounting manipulation, but with a distinction prior work has overlooked. The relation is unconditional for within-GAAP earnings management and conditional on heightened pressure for accounting fraud.
I blogged last month about the possibility of perfect alignment between executive pay and company performance. In this HLS blog, Stephen O’Byrne of Shareholder Value Advisors points out that director pay programs have drawn from the same conventional structures as executive pay – a portion of compensation in cash at market levels and a portion in equity to align directors’ incentives with shareholders’. But according to the blog, this approach to “skin in the game” may not be having the impact that’s intended – because director pay has fallen prey to a common misperception:
Directors and investors tend to think that 60% of pay in stock provides a similar incentive to 60% of wealth in stock, but, in fact, it provides an incentive that is much more varied and often much weaker.
In and of itself, awarding equity to directors isn’t a bad approach. The issue is in how the award amounts at grant and vesting are calculated. Here’s one contributing factor:
Setting target pay equal to market pay regardless of past performance creates a systematic “performance penalty” that reduces leverage and alignment. High stock returns are penalized with a reduction in grant shares (to avoid exceeding target pay), and poor stock returns are rewarded with an increase in grant shares (to maintain target pay).
To get to better alignment, Steve says that directors and investors should focus on “pay leverage” instead of percent of pay in equity. Pay leverage is the ratio of the percent change in cumulative pay, measured on a “mark to market” basis at each year end, to the percent change in cumulative shareholder wealth. Luckily, Steve also explains how to focus on pay leverage, which may be simpler than how it first appears. One step is setting target pay not just at a market value, but market adjusted for trailing relative performance, in order to correct the shortcoming noted above. Additionally:
[S]tock vesting [should take] out the industry component of the stock return. That is, the vesting multiple is 1/(1 + the industry return from the date of grant). Fourth, any cash paid out prior to the end of the measurement period [should be] treated as a draw against the value of the performance shares. In other words, in our context, all stock is held throughout our five year measurement period and doesn’t vest until the end of the five year period.
Reducing the percent of pay in stock reduces leverage but leaves pay alignment nearly perfect. If all directors had a cash retainer equal to 40% of their initial stock grant value and equity compensation that followed the provisions of the perfect correlation pay plan, director pay leverage and alignment would fall in a very narrow range.
Programming note: In observance of Veterans Day, this blog will not run tomorrow. We’ll return on Thursday. Thank you to all of our service members and service member families for your commitment and sacrifices.
As Meredith blogged last week, compensation committees that connect the CEO compensation-setting process to the CEO performance review process are able to make and communicate pay decisions with better context. This Semler Brossy memo shares a sample annual review cycle that helps align these two important processes:
– Goal Presentation (March): The CEO presents annual goals to the Compensation Committee for alignment.
– Mid-Year Check-In (July): The CEO delivers a progress update against annual goals.
– Review Preview (October): The Compensation Committee finalizes assessment questions and processes — including target focus areas, a timeline for completion, and the self-review process — and shares a plan for the upcoming review, highlighting key focus areas such as leadership and strategic and financial direction.”
– CEO Self-Assessment (December): This assessment is shared with the full board as context for upcoming performance discussions.
– Active Review (January): Selected Compensation Committee members can divide up board interviews or send all board members an anonymous survey. In both cases, the Compensation Committee will meet to compile themes and key messages. The Compensation Committee refines those themes (sometimes with the help of a compensation consultant) and shares them with the full board for additional input.
– Results and Performance Review (February): The Board Chair and Compensation Committee Chair present the final review to the Compensation Committee and full board. The committee considers results in the context of next year’s pay decisions. Selected board members, such as the Board Chair and Compensation Chair, schedule and share findings with the CEO, then report back to the full board on how the feedback was received and any necessary follow-up. Ideally, the CEO would also use the next meeting to reflect on the feedback and discuss how it will inform the goals for the coming year.
While it is not included in the above calendar, it can be useful to also schedule a follow-up conversation with the CEO after their performance review. Doing so gives them time to reflect on the feedback and ask questions. The board may also consider setting aside time for its own review of the cycle to determine whether any changes for the following year are warranted.
The memo also dives into the pros and cons of various methods for collecting feedback and offers tips for delivering (sometimes difficult) messages in a way that your CEO can accept and positively act on it. Members can access more resources on these topics in our “Compensation Committees” and “Determining How Much Pay is Appropriate” Practice Areas.
For a few years now, we’ve periodically noted that the 2021 American Rescue Plan Act amended the definition of “covered employee” to add a public company’s five highest compensated employees (even if they are not executive officers) for tax years beginning January 1, 2027 and thereafter. January 1, 2027 is now right around the corner!
This Davis Polk alert addresses some frequently asked questions about the expanded definition. For example:
Q: Will the five highest compensated employees for 2027 be identified based on 2026 or 2027 compensation? This question has not been expressly addressed. Using 2026 compensation would allow companies to identify their five highest compensated employees at the start of 2027. However, because ARPA states, “in the case of taxable years beginning after December 31, 2026, such employee is among the 5 highest compensated employees for the taxable year” (emphasis added), the determination will likely be based on 2027 compensation. If so, companies may not be able to identify these employees until after the end of their 2027 taxable year.
It also suggests some steps that companies may want to take to prepare:
– Review their employee populations to make a preliminary assessment as to who may be their covered employees beginning in 2027,
– Confirm that their systems for tracking compensation are sufficient for this purpose, and
– Consider whether to accelerate any compensation that would otherwise be paid in 2027 into 2026, if it is likely to be disallowed as a tax deduction for 2027.
Most boards have a process for evaluating CEO performance, and most compensation committees have a process for determining CEO pay. Too often, however, those processes operate more independently than they should.
These are the opening lines of this Pearl Meyer alert discussing how to connect CEO performance evaluations to compensation decisions. It says the evaluation and compensation processes should be distinct, but connected, and shares some tips.
One useful practice is to complete the CEO performance evaluation before reaching conclusions on compensation. Doing so helps the board develop a view of performance on its own merits rather than working backward from a particular pay outcome. The compensation committee can then consider what, if any, implications the evaluation should have for compensation.
The process should begin at the start of the performance cycle, when the board and CEO agree on the CEO’s priorities and expectations. Objectives should reflect the company’s strategy and include both quantitative and qualitative measures [. . .] Documenting those expectations helps avoid a common problem: introducing new performance considerations at year-end that were never clearly communicated to the CEO.
In terms of implications for pay, the outcome of the evaluation may provide good context for where the CEO’s pay should be positioned relative to market, and the compensation committee may choose to reflect the evaluation in one or more ways:
– Annual incentive outcomes, particularly where the plan incorporates individual or strategic performance.
– Salary adjustments, although these are generally a relatively small component of CEO compensation.
– Future long-term incentive opportunities, where sustained leadership performance or strategic progress may inform grant sizing.
– Special recognition or retention decisions, particularly during periods of significant transformation or unusual leadership demands.
– The evaluation may also lead the board to conclude that no compensation adjustment is appropriate. Not every aspect of CEO performance needs to result in an incremental pay action.
Yesterday, ISS announced that for companies with annual meetings between February 1, 2027 and September 15, 2027, its peer group review & submission window will open at 9:00 AM ET on Monday, November 9, 2026, and will close at 8:00 PM ET on Friday, November 20, 2026. Submissions should reflect peer companies used (or to be used) by the submitting company for pay-setting for the fiscal year ending prior to the company’s next upcoming annual meeting (so for your 2027 annual meeting, this would mean peers used for the 2026 fiscal year).
Here’s a reminder from the press release:
As part of ISS’ peer group construction process, on a semi-annual basis, corporations are requested to submit changes they have made to their self-selected peer groups for their next proxy disclosure. ISS considers companies’ self-selected peer groups as an important input as part of its own peer group construction methodology.
Companies that have made no changes to their previous proxy-disclosed executive compensation benchmarking peers, or companies that do not wish to provide this information in advance, are under no obligation to participate. For companies that do not submit any information, the proxy-disclosed peers from the company’s last proxy filing will automatically be factored into ISS’ peer group construction process.
This Glass Lewis blog discusses one-time CEO awards at major U.S. banks in 2025 and assesses their impact on pay levels and peer benchmarking. It reports:
During fiscal year 2025, several large U.S. banks granted significant one-time awards (OTA) to their CEOs, primarily for retention, leadership continuity and transaction-related considerations. The awards contributed to a substantial increase in average CEO compensation among the 19 S&P 500 banks reviewed, while median compensation remained relatively stable.
[T]he aggregate value for grants across the sector [rose] from a little over $100 million in FY 2023 to above $430 million in FY 2025, representing an approximate 311% increase.
[J]ust five of the twelve banks that granted one-time awards in FY 2025 [accounted] for nearly 87% (approximately $379 million) of the aggregate recorded value across the sector.
The blog says that it’s common for average pay to exceed median because of a few large packages, but in 2025 the gap between the average and median became especially wide: “the average rose approximately 86% from the prior year, while the median was essentially unchanged.” Glass Lewis shares its concerns about the impact on benchmarking:
This has a practical benchmarking implication. If a company relies on the average of a peer group or cites the average as evidence that its CEO’s pay package is below market, a few OTA-inflated pay outcomes can create an artificially high reference point. Indeed, the FY 2025 average reflected several exceptional compensation outcomes and was therefore less representative of the compensation reported by a typical company in the sample.
The blog illustrates this benchmarking implication with an example.
[One] company disclosed that 80% of its principal peers had granted special CEO awards during the preceding four years and that the average award value was approximately $60.65 million. [The company] then approved an award with an approved value of $60 million. That does not mean the approved value was selected mechanically, but the near match is difficult to ignore. A practice initially presented as exceptional can start to look ordinary once enough peers have adopted it.
It goes on to highlight five awards and explains that the company in the group with the highest say-on-pay support (83%) granted an award with unique features (tied to a transaction and integration) compared to the others (retention-focused, with 70% support or less). It also points out that one-time awards are up outside the banking sector as well and that there hasn’t been an overall decline in say-on-pay support. Say-on-pay challenges are more likely “when award values are exceptionally large, the evidence of an immediate retention threat is limited, or the award lacks objective performance conditions.”
On this blog, we spend a lot of time discussing executive pay, but as our readers well know, a company’s broader employee population is often eligible for awards under the equity plan, and those awards can be deployed in a variety of ways. This Cooley memo discusses where “equity refresh grants” fit in that strategy – noting that they can be an important tool for boosting employee morale and supporting a company’s long-term performance.
The memo discusses strategies, design structures and timing, calculating refresh award values, and communicating with employees. Here’s what it says about forms of equity:
Refresh grants can take various forms depending on the type of company and its equity compensation strategy. Stock options, including both incentive stock options and nonqualified stock options, remain a common form of equity used for refresh grants, particularly at earlier and mid-stage private companies. Restricted stock units (RSUs) are increasingly popular among late-stage private companies, typically companies with a valuation at or above $1 billion. Some companies also use performance-based equity or other structures depending on their specific circumstances and objectives. The choice of equity vehicle for refresh grants often mirrors the type used for initial grants, though companies may adjust their approach as they mature or as market practices evolve.
The memo points out that equity refresh grants carry important tax and legal implications that both employers and employees should understand. On the securities and compliance front, it says:
[C]ompanies must ensure that refresh grants comply with the terms of their equity incentive plans, including any limits on the number of shares available for issuance. Securities law considerations, including registration requirements and exemptions, also apply to refresh grants just as they do to initial equity awards.
Keep in mind that when it comes to public company say-on-pay votes and executive pay, investors sometimes frown on retention awards. As discussed at our Executive Compensation Conference a couple weeks ago, there are factors that can mitigate that risks – and in some cases, the risks are also outweighed by the benefits.
I am already feeling nostalgic about our recent conferences in Orlando – especially after enjoying Meredith’s blog with photo highlights. I have also already consulted my notes a few times and have been eager to refresh my memory on all of the insights that our speakers shared. So, good news! The archives – and transcripts – for the 2026 Proxy Disclosure & 23rd Annual Executive Compensation Conferences are now available!
If you registered for the conferences through our sites, you can access the video archives and transcripts via the access links on the 2026 Conference Archives page. Members of TheCorporateCounsel.net, CompensationStandards.com, Section16.com and DealLawyers.com who registered for the conferences can use their existing logins to access the Proxy Disclosure Archives and the Executive Compensation Archives.
If you are not a member, do not know your password, or are experiencing issues accessing the 2026 Conference archives, please reach out to our Member Services team by calling 800-737-1271 or send an email to info@ccrcorp.com.
Thank you again to all of our sponsors, speakers, hardworking CCRcorp team, and everyone who attended! Each of you made this year’s events extra magical.
This memo from Compensation Advisory Partners analyzed payouts from long-term performance plans over a 10-year period for 100 large U.S. public companies across 11 industries. The goal was to assess payout patterns across market cycles, understand the impact that relative total shareholder return (TSR) metrics have on payout patterns, and give management teams and compensation committees a “rule of thumb” for evaluating the degree of stretch in long-term performance goals. Here are the three key takeaways:
1. Based on our analysis of long-term incentive payouts over a 10-year period, the degree of difficulty, or “stretch” embedded in long-term performance goals translates to a 95% chance of achieving at least Threshold performance, a 70% chance of achieving at least Target performance, and a 20% chance of achieving Maximum performance, suggesting performance goals balance achievability at Threshold and Target with significant “stretch” at Maximum.
2. Funding on relative TSR metrics tends to be more evenly distributed while funding on financial metrics tends to skew toward target and above. This reflects the different roles the metrics play with financial metrics having clearer line-of-sight for plan participants and relative TSR being more of an outcome metric tied to the shareholder experience.
3. Long-term performance plans have generally been effective at aligning pay and performance as the top performers in each cycle consistently paid above target at a higher rate than the broader sample.
We’ve posted this analysis along with other resources for compensation committees and advisors in our “LTIPs” Practice Area.