Pay for Performance? Government Regulation and the Structure of Compensation Contracts

In 1992-1993, the SEC required enhanced disclosure on executive compensation and Congress enacted tax legislation, i.e. Internal Revenue Code Section 162(m), limiting the deductibility of non-performance related compensation over one million dollars. We examine the effects of these regulatory changes and report small and large sample evidence that many million-dollar firms have reduced salaries in response to 162(m) and that salary growth rates have declined post-1993 for the firms most likely to be affected by the regulations. We further document that bonus and total compensation payouts are increasingly sensitive to stock returns after 1993, especially for firms with million-dollar pay packages. We also document that, once we control for factors affecting CEO incentives, the sensitivity of the CEO?s wealth to changes in shareholder wealth has increased from 1993 to 1996 for firms with CEOs approaching the million-dollar mark. Overall, our results suggest that some firms have altered the structure of CEO compensation in response to 162(m) by reducing salaries and that, on average, the pay for performance sensitivity has increased following the regulations, especially for million-dollar firms.

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