A common CEO pay strategy is stalling innovation, a new study reveals why

A pay structure meant to drive corporate success may be doing the opposite. A new study finds that one of the most common forms of CEO compensation – value-based equity grants – can actually weaken executive motivation and stifle innovation by discouraging long-term investments.

The researchers analyzed thousands of U.S. firms from 2006-22 to examine how different executive pay structures influence corporate decision-making. The study, published in the Journal of Financial and Quantitative Analysis, reveals that companies tying CEO stock compensation to a fixed dollar amount can unintentionally weaken executives’ motivation to increase shareholder value. That’s because as stock prices rise, executives receive fewer shares, reducing the reward for strong performance.

What the researchers say: "Boards of directors often design CEO pay structures to balance retention and risk, but our findings show that value-based equity grants can backfire," The lead author told us. "These grants may unintentionally discourage executives from making bold, long-term investments."

Companies typically award CEO stock grants in one of two ways. With share-based grants, executives receive a fixed number of shares and benefit directly when stock prices rise - the better the company performs, the more valuable their equity becomes.

In contrast, value-based grants tie compensation to a fixed dollar amount. The number of shares is adjusted to match that value - so if the stock price is high, executives receive fewer shares and if it’s low, they receive more. This means the total value of the grant is effectively capped at the time of the award, limiting the executive’s potential upside even when the company performs well.

"Under value-based compensation, stronger stock performance actually leads to fewer shares for executives," the researchers explained. "That weakens the reward for driving long-term gains."

The study also found that companies relying on value-based grants tend to invest less in innovation, particularly in research and development, a key engine of long-term growth.

Notably, firms that emphasize value-based pay often prioritize executive retention and compensation predictability over growth-oriented leadership. While this approach can offer short term stability, it may come at the cost of corporate agility and bold decision making.

"When companies focus too much on retention, they may create a system where executives play it safe instead of pursuing ambitious growth strategies," said the lead author.

Strong corporate governance is often seen as a safeguard against flawed compensation models. However, the study finds that even in well governed firms, value-based pay structures still weaken CEO incentives.

"Good governance can prevent many executive pay abuses, but it does not completely fix the disincentives created by value-based equity grants," he continued. "Even in firms with strong oversight, we still see reduced investment in innovation."

The researchers measured governance strength using established firm-level governance scores and compared innovation spending - particularly research and development investment - across companies with varying levels of board oversight. Even in companies with stronger governance, value-based pay was still linked to lower innovation.

Companies with strong governance were also more likely to adopt value-based grants, possibly because they have better internal controls. But the data suggests those controls don’t fully offset the disincentive effects. Governance alone isn’t enough to prevent the unintended consequences of these pay structures.

Over the past two decades, companies have increasingly shifted from share-based to value-based compensation. The study finds that in 2006, 60 percent of firms used value-based equity grants - a figure that grew to 73 percent by 2022. Meanwhile, share-based compensation declined from 40 percent to 27 percent over the same period.

"As more firms adopt value-based pay, they need to recognize the long-term trade-offs," the researchers noted. "A growing reliance on this model could mean lower innovation and slower corporate growth."

This trend suggests that more companies are prioritizing pay predictability over performance-driven incentives, which could have long-term consequences for corporate growth.

One of the core tensions in CEO compensation is balancing retention with strategic leadership.

Value-based pay structures offer companies stability and help retain top executives by reducing compensation volatility. But the study shows that this trade-off often comes at a cost - lower appetite for risk and reduced investment in long-term innovation.

"Retention and strategic incentives should not be at odds with each other," the researchers said. "Boards need to design compensation models that not only keep top talent but also push them to drive sustained company growth."

For corporate boards, this presents a clear dilemma: Should they prioritize predictable compensation or structure pay to encourage innovation and forward-looking leadership? The study suggests that a hybrid model, combining elements of both share-based and value-based pay, may offer a better balance between retaining executives and driving long-term performance.

Investors should take note. Companies that rely heavily on value-based grants may prioritize stability over bold leadership and long-term growth - potentially signaling weaker future performance.

"As executive pay continues to evolve, investors should take a closer look at not just how much CEOs are paid, but how they are paid," the lead author said. "The structure of compensation plays a huge role in shaping corporate behavior."

My take: The whole issue of corporate - and other - leadership is presently undergoing intense research, especially since scientists discovered a few years ago that all leaders, from the lowest level to the imperial CEO share a cluster of the same genes.

Those genes are shared by about 5% of the population, and include psychopaths, bullies and narcissists. Many corporate and political leaders share characteristics that distinguish all of the above.

That does not mean that all leaders are bullies or psychopaths or narcissists, far from it. However, it does mean that if they have certain set of experiences in childhood or function in contexts favorable to psychopathy etc. their propensity for the negative personality traits may come to dominate their behavior.

Research has shown that psychopaths and bullies tend to advance more quickly in corporations or politics and to be paid more.

It would be interesting to discover which means of remuneration create the conditions in which leaders turn to their “dark side of the force.”