Innovation in Pay‐Performance Sensitivity Estimation: Evidence From the New 2022 SEC 's Corporate Disclosure Rules

ABSTRACT

Contrary to the predictions of optimal contracting theory, prior empirical research has struggled to identify a strong economic link between board‐authorised CEO compensation and firm performance—commonly referred to as pay‐performance sensitivity ( PPS ). Is the economically weak PPS due to an unexpectedly small stock‐based component in board‐authorised compensation, or to the omission of CEOs' personal shareholdings from total compensation, as prior studies suggest? Or, as we propose, does it instead stem from a flaw in how board‐authorised CEO pay is measured? To answer this question, we leverage a recent SEC rule requiring the disclosure of a new metric for board‐authorised total compensation—‘Compensation Actually Paid’—and document a strong and economically significant link between board‐authorised CEO total pay and firm performance. The key contribution lies in the findings, which are consistent with the SEC's perspective: the failure of prior research to document economically significant PPS is not attributable to boards' neglect in designing incentive‐compatible CEO pay packages or to the exclusion of CEO s' personal shareholdings. Rather, it stems from the use of an inferior metric in prior studies to measure board‐authorised compensation incentives. Grant‐date stock‐based compensation values, which underlie the old total compensation metric, fail to reflect how the award aligns CEO incentives with shareholder interests. The findings should inform boards, investors, and regulators.