Stock Buyback Ability to Enhance CEO Compensation: Theory, Evidence, and Policy Implications

Authors

Nitzan Shilon, Peking University School of Transnational Law

First Page

303

Abstract

I report that stock buyback ability to enhance CEO compensation has reached a record high amount corresponding to one-third of total pay. Also, I refute the common wisdom that this ability is attributed mainly to buyback impact on per share criteria that determine annual bonuses. Instead, I show that because of recent reforms in executive compensation design, the ability of buybacks to boost the amount of CEO stock-based compensation has become ten times higher than their potential to increase annual bonuses. I argue, first, that the potential of stock buybacks to enhance their compensation provides CEOs with incentives to conduct buybacks excessively and op- portunistically. Second, I explain that this ability motivates CEOs to game their incentive compensation arrangements and turn them from pay for performance into pay for manipulation. Third, I argue that firms camouflage the ability of stock buybacks to increase executive pay. Fourth, I explain that CEOs do not only have the incentives to abuse buybacks but they also have the power to act on these incentives, and that buyback activity is consistent with their incentives. Fifth, I argue that these distorted incentives are likely to lead firms to underinvest in productive capabilities, disguise poor financial performance, and contribute to the creation of a market bubble that increases the likelihood of another financial crisis. Borrowing from dividend protection, which safeguards executive stock and option awards from the automatic decline in the stock price that dividends trigger, I suggest applying buyback protection, which would shield executive pay from the mechanical performance improvement that stock buybacks stimulate. Because I do not expect a mandatory buyback protection rule to be effective, I propose making the impact of stock buybacks on executive pay transparent. Transparency can be expected to push boards, shareholders, and proxy advisors to pressure firms to adopt buyback protection.

Recommended Citation

Nitzan Shilon, Stock Buyback Ability to Enhance CEO Compensation: Theory, Evidence, and Policy Implications, 25 Lewis & Clark L. Rev. 303 (2021).
Available at: https://lawcommons.lclark.edu/lclr/vol25/iss1/8