1 Working Paper WP No 601 July , 2005 GOVERNANCE STRUCTURE AND THE WEIGHTING OF PERFORMANCE MEASURES IN CEO COMPENSATION

We empirically examine how governance structure affects the design of executive compensation contracts and, in particular, the implicit weights of firm performance measures in CEO compensation. We find that compensation contracts in firms with higher takeover protection and where the CEO has more influence on governance decisions put more weight on accounting-based measures of performance (return on assets) than on stockbased performance measures (market returns). In additional tests, we further find that CEO compensation in these firms has lower variance and a higher proportion of cash (versus stock-based) compensation. We further find that CEOs’ incentives (measured as changes in CEO annual wealth, which includes changes in the value of CEOs’ equity holdings, in addition to yearly compensation) do not vary across governance structures. These findings are consistent with CEOs in firms with high takeover protection and where they have more influence on governance being able to influence the contracting.