Pay for performance? Government regulation and the structure of compensation contracts

In 1992-1993, the SEC required enhanced disclosure on executive compensatio n and Congress enacted tax legislation limiting the deductibility of non-pe rformance related compensation over one million dollars, i.e. Internal Reve nue Code Section 162(m). We examine the effects of these regulatory changes and report small and large by the regulations. We further document that bo nus and total compensation payouts are increasingly sensitive to stock retu rns after 1993, especially for firms with million-dollar pay packages. We a lso document that, once we control for other factors affecting CEO incentiv es, the sensitivity of the CEO's wealth to changes in shareholder wealth ha s increased from 1993 to 1996 for firms with CEOs near or above the million dollar compensation level. Overall, our results suggest that some firms ha ve reduced salaries in response to 162(m). More importantly, the pay for pe rformance sensitivity, measured using total annual compensation and firm-re lated CEO wealth, has increased for firms likely to be affected by 162(m). (C) 2001 Elsevier Science S.A. All rights reserved.