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 What Investors Need to Know aboutExecutive Pay
 Authors:Stephen F. O’ByrneShareholder Value AdvisorsLarchmont, NY, USA 10538sobyrne@valueadvisors.comandS. David YoungINSEADBoulevard de Constance77305 FontainebleauFrancedavid.young@insead.eduMarch 9, 2009
 
  Abstract
. Public company disclosures give analysts a comprehensive measure of top management’s total compensation, but do not provide a comprehensive measure of management’s incentive to increase shareholder value. We present comprehensive measures of management’s value and growth incentives. Our  incentive measures (“value wealth leverage” and “revenue wealth leverage”) show the sensitivity of management wealth to changes in shareholder wealth and changes in revenue. We show how investors can use these measures todetermine whether top management has a strong value creation incentive, a strong incentive to pursue value-destroying growth, or neither. We also present  findings from our study of S&P 1500 companies, including an analysis of the impact of value wealth leverage on subsequent shareholder returns. Our results  show that companies with high value wealth leverage tend to outperform other  firms, in terms of excess returns, but the effects are concentrated among value(as opposed to growth) firms.
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Disclosure requirements recently imposed by the Securities andExchange Commission (SEC) give investors a comprehensive measure of topmanagement’s total compensation, but do not provide a comprehensivemeasure of management’s incentive to increase shareholder value. In thisarticle, we present two comprehensive incentive measures: the sensitivity of management wealth to changes in shareholder wealth (“value wealthleverage”) and the sensitivity of management wealth to changes in revenue(“revenue wealth leverage”). We show how investors can use thesemeasures to answer four important questions:1.
 
How strong is management’s incentive to create shareholder value?2.
 
How strong is management’s incentive to grow revenues?3.
 
Does management have an incentive to pursue value-destroyingrevenue growth?4.
 
Is higher value wealth leverage (i.e., strong wealth creation incentives)associated with significant excess returns?
Percent of pay at risk: the conventional way to think aboutincentives
Exhibit 1 shows the 2006 total compensation of ExxonMobil CEO Rex Tillersonreported under the new SEC disclosure rules. The total compensationdisclosure makes it fairly easy to calculate the conventional measure of incentive strength, the percent of pay that is “at risk.” The only complicationfor Tillerson is the need to split the change in pension value into twocomponents because the pension is based on salary and bonus.
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