The more shares CEO owns, the higher stock return

shares CEO owns

There is too much evidence that the more shares CEO owns, the higher the return on the stock of the company.

Disparity between CEO and employee

Executive compensation is a controversial topic. American CEOs earn 373 times what the average worker makes, so it takes them less than a day to earn what the average worker makes in a year. But for all the attention and outrage that has drawn the most, pay levels are actually not that important to company value.

The average salary at a Fortune 500 company is $13.5 million—a lot of money by anyone’s standards. However, the average size of the largest 500 companies is $10 billion, so the pay is only 0.135%. That’s not to say that compensation levels don’t matter – a company can’t get bored with $13.5M (otherwise you can justify every wasteful spend as paltry compared to the company’s value) – but other aspects of compensation can be more important.


In particular, even more important than pay level is pay sensitivity—how it varies with performance. However, this dimension is also controversial, especially the use of bonuses. Bonuses are usually awarded for “on target” performance (while many rank-and-file employees are paid just for “on target” performance).

Equity compensation — giving CEOs stock — solves many of these problems. In the long run, the stock price has all the avenues a CEO can use to increase the value of the company — if he pollutes the environment, invests in his employees, reorganizes, all of which ultimately affect the value of the company. (Of course, the key word is “long term”, so the stock should have a long vesting period). No ambiguity over incentives (sales growth or earnings growth?) or what goals to set (2% or 5%?) and no asymmetry – the value of CEO stock rises with good performance and falls with bad performance .

Manipulating stock prices

But performance goals can be too simple; CEOs can game the system and focus on one goal while ignoring others. For example, bonuses based on sales or earnings growth can lead CEOs to ignore corporate culture. Furthermore, while higher bonuses are paid for good performance (rather than hitting the target), sometimes the bonus for poor performance is barely reduced—an asymmetrical “heads I win, tails I don’t lose” situation.

But where is the evidence? In a famous 2014 paper in the Journal of Finance, Ulf von Lilienfeld-Toal and Stefan Ruenzi found that a strategy of buying stocks in which the CEO owns a high percentage and shorting stocks in which he owns a low Take 4 -10% (depending on the definition of “high” and “low”). The results suggest that not only are CEO incentives “important,” but that the market doesn’t appreciate their importance. While CEO stakes are public information, the market largely ignores them (perhaps because, like the media, it focuses on pay levels) – so investors can get handsome returns on their deals.

Derived ills

Of course, correlation does not imply causation. This positive correlation may be due to the fact that CEOs have inside information about the firm’s value and are more willing to accept stock (rather than cash) when higher future stock returns are expected. So, to show that the effect is causal—high equity leads to better decision-making by the CEO—they show that the effect is greater in an environment where the CEO has more discretion. Among these companies:

  • High sales growth, which gives managers resources to waste (e.g. free cash) and power (the board is less likely to intervene if the CEO achieves high sales growth)
  • Low institutional ownership and weak external governance – when investors don’t monitor the CEO, he has more discretion
  • Product market competition is weak. If the product market is highly competitive, the CEO must maximize value (even if his equity incentives are weak) to stay in business; if there is little competition, the CEO will slacken
  • The CEO is the founder and also associated with power

As with any paper, this paper has some open questions. The authors include only shares held voluntarily by the CEO (ie, vested but not yet sold by the CEO). They do not include unvested stock nor options. Unvested stocks and options also provide the CEO with an incentive to maximize value, so I’m curious to see if the results hold when these dimensions are included (any investor looking to use this as a trading strategy might want to backtest the strategy, including All incentives – vested stock, unvested stock and options).

In any case, the paper makes a very important contribution by highlighting the dimensions of CEO pay that investors, the media, and the public should focus on—sensitivity rather than level pay—and showing that equity can have a causal effect on firm performance, Rather than simply reflecting the CEO’s private information.

CEO’s pocket

The CEO himself is a major shareholder, so he will work harder to keep his pockets tight, hoping to increase his wealth. If you are the founder and CEO, you usually hold a lot of shares, so you will be more motivated.

In modern U.S. stock-listed companies, the main income of most professional managers and CEOs is stocks, not cash. Cash is usually only a very small percentage of annual salary, and the larger the company, the lower the percentage of cash.

Not only that, most listed companies will use the company’s stock price compensation as the main review standard for the CEO’s performance appraisal. If investors are hardworking, they will find that the annual reports of listed companies will have a subsection, which shows the company’s stock price return in the past year in a chart, and compares it with the stock market and its peers.

shares CEO owns

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