The choice of performance measures, target setting and vesting levels in UK firms’ CEO compensation contract

This paper analyses the influences on the choice of performance measure in CEO compensation contracts, for a sample of 3400 plans from 400 UK firms between 2007 and 2015. We analyse the link between the choice of performance measure and the volatility of earnings per share (EPS) and total shareholder return (TSR), taking into account four different performance categories, in that a firm may use either EPS or TSR, or both, or neither. This allows us to utilise a comprehensive cross-section of plans and account for when both EPS and TSR are jointly employed. Our results are robust to controlling for plan types, consultant, industry, and time specific effects. We find that EPS in combination with TSR is the most common performance metric employed by firms. We also find that firms with higher EPS volatility and lower TSR volatility are more likely to choose TSR as a performance measure, and that firms with higher EPS volatility are less likely to choose EPS alone; we argue that these results are consistent with optimal contracting theory. Secondly, we conduct a novel, detailed description of the performance measures, comparator groups, plan choices, threshold targets and vesting levels at minimum and maximum threshold, used in the construction of CEO compensation contracts. Descriptive statistics provide new detail on the different types of EPS measure used in compensation contracts, and in the case of TSR measures, reveal new information on the choice of comparator groups (FTSE indices vs. self- selected peer groups vs. sector peers). We further argue that commonalities across firms in the elements of target-setting are evidence for institutional isomorphism.