(30) Owning Shares Does Not Guarantee Alignment

Shared losses prove less than they seem

Bank chief executives entered the financial crisis with substantial wealth exposed to their own institutions. In “Bank CEO Incentives and the Credit Crisis”, Rüdiger Fahlenbrach and René Stulz found that banks whose CEOs had stronger shareholder incentives performed no better during the crisis. Their CEOs suffered substantial losses. The evidence did not support the comforting explanation that managers had escaped the risks they imposed on investors.

That finding needs careful interpretation. Losing money together can result from shared mistakes, inadequate information or risks that looked reasonable beforehand. A bad outcome does not establish a conflict of interest. It does establish the limits of using executive ownership as assurance that shareholders are protected.

Alignment between management and shareholders depends on the decisions a reward system makes attractive. My proposition is that, among otherwise comparable arrangements, exposure retained through the consequences of a decision should discourage premature extraction more effectively than an equivalent holding that can be sold before those consequences emerge. Voting power and the shape of the executive’s payoff can still alter that effect.

The familiar agency problem, formalised by Michael Jensen and William Meckling, survives the first share purchase. Managers retain private benefits, career concerns and influence over corporate resources. An ownership percentage compresses those differences into one reassuring number.

Even the shareholder side needs definition. José-Miguel Gaspar, Massimo Massa and Pedro Matos found different acquisition outcomes associated with institutional investors’ holding horizons. Alex Edmans’s review of blockholders explains how large owners can monitor management while also pursuing benefits unavailable to smaller shareholders. For this discussion, alignment means encouraging durable value per share within the company’s risk constraints. Agreement with whichever investor is currently loudest is a weaker standard.

The strongest case for ownership

There is substantial evidence in favour of giving managers equity. Jensen and Kevin Murphy’s work on executive incentives included existing stockholdings alongside salary, options and dismissal. Brian Hall and Jeffrey Liebman subsequently demonstrated that changes in the value of CEOs’ stock and option portfolios produced substantial sensitivity to company performance. Reading the annual bonus alone misses much of the economic contract.

John Core and David Larcker’s research on mandatory ownership plans provides a practical counterargument to scepticism. Firms adopting the plans began with relatively low managerial ownership and weak performance; increased ownership was followed by improved operating and stock performance. Larcker and Brian Tayan discuss the result in their Stanford research review. For executives with insufficient exposure, requiring a meaningful stake can address a real problem.

Retained ordinary shares also avoid the need to specify every valuable activity in advance. A successful product, a sensible acquisition and the abandonment of an expensive mistake can all contribute to the same equity value. That breadth is attractive compared with a contract assembled from narrow targets.

The difficulty is extrapolating from useful ownership to an optimal percentage. Randall Morck, Andrei Shleifer and Robert Vishny found a non-linear relationship between managerial ownership and valuation. Charles Himmelberg, Glenn Hubbard and Darius Palia showed how underlying firm characteristics complicate causal interpretation. Kornelia Fabisik and co-authors further demonstrated that sample composition and insiders’ responses to past performance affect the relationship.

Ownership can therefore be both an incentive and an outcome. Successful founders may sell shares to diversify; poorly performing firms may retain concentrated insider holdings. A screen that mechanically prefers the larger percentage risks confusing the history of the holding with its effect on the next decision.

The date of sale changes the decision

Consider an illustrative acquisition whose integration costs become clear after five years. A CEO able to sell most of an award after two years can benefit from early enthusiasm while retaining limited exposure to eventual disappointment. The number of shares at announcement reveals little about that sequence.

Alex Edmans, Vivian Fang and Katharina Lewellen linked scheduled equity vesting to reductions in investment. Tomislav Ladika and Zacharias Sautner examined an unusually useful setting: companies accelerated option vesting before an accounting change. Using variation in the rule’s implementation timing, they found investment cuts, higher short-term earnings and subsequent executive equity sales. Their evidence concerns firms affected by that particular change; it does not establish that every investment reduction around vesting is destructive.

Information timing matters too. Edmans, Luis Goncalves-Pinto, Moqi Groen-Xu and Yanbo Wang found that discretionary news releases clustered around vesting months. The potential conflict extends beyond project selection to when investors receive favourable information.

Buybacks require greater caution. Edmans, Fang and Allen Huang associated vesting incentives with repurchases and acquisitions followed by weaker longer-term outcomes. A paper published in 2025 by Ingolf Dittmann, Amy Yazhu Li, Stefan Obernberger and Jiaqi Zheng challenged the repurchase interpretation. Earnings announcements and trading restrictions could explain why repurchases and equity compensation coincided. Temporal proximity alone is insufficient evidence of managerial opportunism.

The defensible response is to examine sale eligibility against the investment cycle. Radhakrishnan Gopalan and co-authors found longer compensation duration in firms with longer-lived assets and greater research intensity. That relationship supports a question boards can answer concretely: when will the capital committed today produce enough evidence to judge the decision? Retention ending well before that date needs a commercial explanation.

Equal share exposure can produce unequal risk appetites

An executive’s personal balance sheet differs from a diversified investor’s portfolio. Salary, future employment and company shares may deteriorate together. Hall and Kevin Murphy’s analysis of undiversified executives explains why the personal value of an option award can differ substantially from its cost to the company. Requiring more concentrated exposure can make an executive reluctant to undertake worthwhile risky investments.

Options complicate the picture further. Their value responds differently to changes in the share price and its volatility. Jeffrey Coles, Naveen Daniel and Lalitha Naveen associated stronger sensitivity to volatility with riskier investment and financing policies. Options can lose their entire value, but their payoff still differs from that of ordinary shares.

Debt-like compensation introduces another incentive. Rangarajan Sundaram and David Yermack documented executive pensions and their association with conservatism. Edmans and Qi Liu modelled how inside debt can reduce incentives to transfer risk to creditors. Cory Cassell and co-authors associated larger inside-debt holdings with less risky corporate policies. Yet Chenyang Wei and Yermack found that disclosures of substantial inside debt could benefit bondholders while equity and total enterprise values fell. Reducing risk has costs as well as benefits.

This distinction is particularly consequential in banking. Andrea Beltratti and Stulz found that shareholder-friendly boards did not protect banks’ crisis performance. Luc Laeven and Ross Levine connected shareholder power with bank risk-taking, while Stulz’s work on risk governance distinguishes choosing economically justified risks from minimising risk altogether.

The inference is uncomfortable but useful. Better alignment with shareholders can coexist with greater danger to creditors or financial stability. A board must specify whose exposure it is trying to align and which risks the company is authorised to take. “Everyone owns stock” leaves both questions unanswered.

Targets and control can undo the contract

A share award can still vest against a narrow accounting target. Bengt Holmström and Paul Milgrom’s multitask analysis explains why rewarding the measurable part of a job can redirect attention from valuable activities that are harder to observe. Earnings growth, for example, can reward expansion without adequately charging for the capital consumed. This is part of the governance cost of diversification.

John Graham, Campbell Harvey and Shiva Rajgopal’s survey documented executives’ willingness to sacrifice economic value to meet reporting objectives. Survey responses describe stated preferences and cannot establish how often respondents acted on them. Nor does equity compensation imply fraud: Christopher Armstrong, Alan Jagolinzer and Larcker found no positive association between equity incentives and accounting irregularities after matching executives on observable characteristics. The concern includes lawful decisions that satisfy a target while weakening the business.

Market measures also contain luck. Marianne Bertrand and Sendhil Mullainathan found that governance affected how much CEOs were rewarded for external events. Robert Gibbons and Murphy’s work on relative performance evaluation explains the attraction of removing common shocks from pay. Peer selection and benchmark design consequently deserve scrutiny alongside the headline award.

Control determines who can enforce that scrutiny. Lucian Bebchuk and Jesse Fried argue that the compensation-setting process can itself contain an agency problem. Coles, Daniel and Naveen associated boards appointed during a CEO’s tenure with weaker monitoring. Bebchuk, Martijn Cremers and Urs Peyer linked a larger CEO share of top-management pay with weaker governance outcomes. Neither measure proves capture in an individual company.

Voting structures add another dimension. Cremers, Beni Lauterbach and Anete Pajuste found that the valuation advantage of dual-class firms dissipated with age. Economic exposure and voting authority can evolve differently. A substantial holding offers limited reassurance when the holder can also prevent effective challenge.

More exposure is not always better

The strongest alternative to complicated performance plans remains straightforward, retained equity supported by competent directors. Its advantages deserve weight. The broad compensation review by Edmans, Xavier Gabaix and Dirk Jenter finds evidence relevant to both efficient contracting and managerial power; a single explanation cannot account for every contract.

There are also limits to financial engineering. Gibbons and Murphy show how career concerns interact with explicit incentives. In field research, Edmans, Tom Gosling and Jenter found that directors and investors placed considerable importance on intrinsic motivation and reputation. Their survey also exposed disagreements over whether extending incentive horizons would improve decisions. Longer retention carries a price in concentration, liquidity and potentially recruitment costs.

My preference is for staged release calibrated to the business, with continued exposure after departure where important consequences remain unresolved. Bebchuk and Fried’s work on long-term performance warns about unrestricted unwinding and retirement cliffs. The “Dynamic Incentive Accounts” model developed by Edmans, Gabaix, Tomasz Sadzik and Yuliy Sannikov offers a theoretical rationale for phased payouts and continuing exposure. Neither establishes a universal holding period.

Ownership also needs information capable of changing a decision. A CEO can be personally exposed and sincerely convinced by an inaccurate operating narrative. As discussed in Truth Has an Operating Cost, independent measurement and protected challenge require resources. Increasing the executive’s stake cannot supply missing evidence.

The relevant trade-off is therefore specific. How much exposure is needed to make a costly mistake personally consequential, without making sensible experimentation personally intolerable? The answer will differ between an established utility and a research business with uncertain commercial outcomes.

Put the payout beside the capital plan

A remuneration committee should review the executive’s total exposure under the same scenarios used to approve strategy. Include existing shares, options, pensions, future vesting, permitted hedges and departure terms. Model successful expansion, delayed integration, refinancing stress and an impairment recognised after the CEO leaves. Show both wealth still at risk and proceeds already available for sale.

Public disclosures offer starting points. The SEC’s pay-versus-performance rules require specified comparisons of compensation and performance. Its hedging-policy rule requires disclosure of policies; it does not itself prohibit hedging. A reported ownership figure therefore needs to be read with the arrangements that can offset its economic exposure.

The UK Corporate Governance Code 2024 provides a more explicit horizon reference. Within its comply-or-explain framework, Provision 36 normally expects combined vesting and holding periods of at least five years and a formal post-employment shareholding policy. Its guidance also supports discretion over formulaic outcomes. The OECD’s 2023 governance principles similarly connect remuneration oversight with long-term interests and independent judgement.

Recovery rights need precise boundaries. The SEC’s 2022 compensation-recovery rules address erroneously awarded incentive pay following qualifying accounting restatements. They do not recover every reward associated with a disappointing strategy. Broader contractual protections require clear triggers and credible enforcement. Directors must avoid turning discretion into retrospective accommodation for an influential CEO.

That work belongs alongside the board’s assessment of execution risk. Before approving the next major investment, directors should require a dated schedule comparing when its economics become observable with when the responsible executives can realise their rewards. Any substantial gap should return to the remuneration committee with an owner, a proposed adjustment and a recorded explanation before the capital is committed.

Sources

Ownership, incentives and shareholder interests

1. Michael C. Jensen and William H. Meckling, "Theory of the Firm: Managerial Behavior, Agency Costs, and Ownership Structure" https://gwern.net/doc/economics/1979-jensen-3.pdf

2. Michael C. Jensen and Kevin J. Murphy, "Performance Pay and Top-Management Incentives" https://www.journals.uchicago.edu/doi/10.1086/261677

3. Brian J. Hall and Jeffrey B. Liebman, "Are CEOs Really Paid Like Bureaucrats?" https://www.nber.org/papers/w6213

4. David F. Larcker and Brian Tayan, "Equity, Insider Trading, & Restatements" https://gsbpreserve.stanford.edu/file/87200/content

5. Randall Morck, Andrei Shleifer and Robert W. Vishny, "Management Ownership and Corporate Performance: An Empirical Analysis" https://www.nber.org/papers/w2055

6. Charles P. Himmelberg, R. Glenn Hubbard and Darius Palia, "Understanding the Determinants of Managerial Ownership and the Link Between Ownership and Performance" https://www.nber.org/papers/w7209

7. Kornelia Fabisik, Rüdiger Fahlenbrach, René M. Stulz and Jérôme P. Taillard, "Why are Firms with More Managerial Ownership Worth Less?" https://www.nber.org/papers/w25352

8. José-Miguel Gaspar, Massimo Massa and Pedro Matos, "Shareholder investment horizons and the market for corporate control" https://www.darden.virginia.edu/sites/default/files/inline-files/gasparmassamatoshorizonsmajfeapr05.pdf

9. Alex Edmans, "Blockholders and Corporate Governance" https://alexedmans.com/wp-content/uploads/2024/06/BlockholdersSurvey.pdf

10. Alex Edmans, Xavier Gabaix and Dirk Jenter, "Executive Compensation: A Survey of Theory and Evidence" https://www.nber.org/papers/w23596

Vesting, investment and the timing of rewards

11. Alex Edmans, Vivian W. Fang and Katharina A. Lewellen, "Equity Vesting and Managerial Myopia" https://www.nber.org/papers/w19407

12. Tomislav Ladika and Zacharias Sautner, "Managerial Short-Termism and Investment: Evidence from Accelerated Option Vesting" https://academic.oup.com/rof/article/24/2/305/5529965

13. Alex Edmans, Luis Goncalves-Pinto, Moqi Groen-Xu and Yanbo Wang, "Strategic News Releases in Equity Vesting Months" https://www.ecgi.global/publications/working-papers/strategic-news-releases-in-equity-vesting-months

14. Alex Edmans, Vivian W. Fang and Allen H. Huang, "The Long-Term Consequences of Short-Term Incentives" https://www.ecgi.global/publications/paper-publications/the-long-term-consequences-of-short-term-incentives

15. Ingolf Dittmann, Amy Yazhu Li, Stefan Obernberger and Jiaqi Zheng, "Equity-based compensation and the timing of share repurchases: the role of the corporate calendar" https://www.ecgi.global/publications/working-papers/equity-based-compensation-and-the-timing-of-share-repurchases-the-role

16. Radhakrishnan Gopalan, Todd Milbourn, Fenghua Song and Anjan V. Thakor, "Duration of Executive Compensation" https://onlinelibrary.wiley.com/doi/10.1111/jofi.12085

17. Lucian A. Bebchuk and Jesse M. Fried, "Paying for Long-Term Performance" https://www.law.upenn.edu/live/files/19-bebchuk158upalrev19152010pdf

18. Alex Edmans, Xavier Gabaix, Tomasz Sadzik and Yuliy Sannikov, "Dynamic Incentive Accounts" https://www.nber.org/papers/w15324

Risk, personal wealth and inside debt

19. Brian J. Hall and Kevin J. Murphy, "Stock Options for Undiversified Executives" https://www.nber.org/papers/w8052

20. Jeffrey L. Coles, Naveen D. Daniel and Lalitha Naveen, "Managerial incentives and risk-taking" https://researchdiscovery.drexel.edu/esploro/outputs/journalArticle/Managerial-incentives-and-risk-taking/991020537627904721

21. Rangarajan K. Sundaram and David L. Yermack, "Pay Me Later: Inside Debt and Its Role in Managerial Compensation" https://onlinelibrary.wiley.com/doi/10.1111/j.1540-6261.2007.01251.x

22. Alex Edmans and Qi Liu, "Inside Debt" https://alexedmans.com/wp-content/uploads/2024/06/Edmans-Liu-11-Inside-Debt.pdf

23. Cory A. Cassell, Shawn X. Huang, Juan Manuel Sanchez and Michael D. Stuart, "Seeking safety: The relation between CEO inside debt holdings and the riskiness of firm investment and financial policies" https://asu.elsevierpure.com/en/publications/seeking-safety-the-relation-between-ceo-inside-debt-holdings-and-/

24. Chenyang Wei and David Yermack, "Deferred Compensation, Risk, and Company Value: Investor Reactions to CEO Incentives" https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr445.pdf

25. Rüdiger Fahlenbrach and René M. Stulz, "Bank CEO Incentives and the Credit Crisis" https://www.nber.org/papers/w15212

26. Andrea Beltratti and René M. Stulz, "Why Did Some Banks Perform Better During the Credit Crisis? A Cross-Country Study of the Impact of Governance and Regulation" https://www.nber.org/papers/w15180

27. Luc Laeven and Ross Levine, "Bank Governance, Regulation, and Risk Taking" https://www.nber.org/papers/w14113

28. René M. Stulz, "Governance, Risk Management, and Risk-Taking in Banks" https://www.nber.org/papers/w20274

Targets, managerial power and non-financial incentives

29. Bengt Holmström and Paul Milgrom, "Multitask Principal–Agent Analyses: Incentive Contracts, Asset Ownership, and Job Design" https://web.stanford.edu/~milgrom/publishedarticles/Multitask%20Principal%20Agent.pdf

30. John R. Graham, Campbell R. Harvey and Shiva Rajgopal, "The Economic Implications of Corporate Financial Reporting" https://www.nber.org/papers/w10550

31. Christopher S. Armstrong, Alan D. Jagolinzer and David F. Larcker, "Chief Executive Officer Equity Incentives and Accounting Irregularities" https://onlinelibrary.wiley.com/doi/10.1111/j.1475-679X.2009.00361.x

32. Marianne Bertrand and Sendhil Mullainathan, "Do CEOs Set Their Own Pay? The Ones Without Principals Do" https://www.nber.org/papers/w7604

33. Robert Gibbons and Kevin J. Murphy, "Relative Performance Evaluation for Chief Executive Officers" https://www.nber.org/papers/w2944

34. Lucian Arye Bebchuk and Jesse M. Fried, "Executive Compensation as an Agency Problem" https://www.nber.org/papers/w9813

35. Jeffrey L. Coles, Naveen D. Daniel and Lalitha Naveen, "Co-opted Boards" https://sites.temple.edu/lnaveen/files/2020/11/co-option_RFS_2014.pdf

36. Lucian A. Bebchuk, Martijn Cremers and Urs Peyer, "CEO Centrality" https://www.nber.org/papers/w13701

37. Martijn Cremers, Beni Lauterbach and Anete Pajuste, "The Life-Cycle of Dual Class Firm Valuation" https://www.ecgi.global/publications/working-papers/the-life-cycle-of-dual-class-firm-valuation

38. Robert Gibbons and Kevin J. Murphy, "Optimal Incentive Contracts in the Presence of Career Concerns: Theory and Evidence" https://www.nber.org/papers/w3792

39. Alex Edmans, Tom Gosling and Dirk Jenter, "CEO Compensation: Evidence From the Field" https://www.ecgi.global/sites/default/files/working_papers/documents/ceocompensation_0.pdf

Governance codes and disclosure rules

40. Financial Reporting Council, "UK Corporate Governance Code 2024" https://media.frc.org.uk/documents/UK_Corporate_Governance_Code_2024_a2hmQmY.pdf

41. Financial Reporting Council, "Corporate Governance Code Guidance" https://www.frc.org.uk/library/standards-codes-policy/corporate-governance/corporate-governance-code-guidance/

42. OECD, "G20/OECD Principles of Corporate Governance 2023" https://www.oecd.org/content/dam/oecd/en/publications/reports/2023/09/g20-oecd-principles-of-corporate-governance-2023_60836fcb/ed750b30-en.pdf

43. U.S. Securities and Exchange Commission, "Pay Versus Performance" https://www.sec.gov/rules-regulations/2022/08/pay-versus-performance

44. U.S. Securities and Exchange Commission, "SEC Adopts Final Rules for Disclosure of Hedging Policies" https://www.sec.gov/newsroom/press-releases/2018-291

45. U.S. Securities and Exchange Commission, "SEC Adopts Compensation Recovery Listing Standards and Disclosure Rules" https://www.sec.gov/newsroom/press-releases/2022-192