Six Challenges in Designing Equity-Based Pay

Brian J. Hall

NOM Unit Head, Harvard Business School; National Bureau of Economic Research (NBER)

Journal of Applied Corporate Finance, Vol. 15, Spring 2003


During the past two decades, there has been a dramatic increase in equity-based pay for executives. This paper analyzes why the primary goal of the equity-pay explosion–creating long-run ownership incentives for top executives–has often been difficult to achieve in practice. More generally, I describe six challenges in the design of equity-based pay plans and discuss potential solutions. The six challenges involve:

1. mismatched time horizons;

2. gaming;

3. the value-cost «wedge»;

4. the leverage-fragility tradeoff;

5. aligning risk-taking incentives; and

6. avoiding excessive compensation.

The paper also discussed the merits of stock versus options and concludes that restricted stock is often a superior form of compensation.

Six Challenges in Designing Equity-Based Pay

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