According to new research, a compensation model designed to incentivise corporate success may do the opposite. A recent study reveals that one of the most prevalent forms of CEO remuneration — value-based equity grants — can inadvertently dampen executive motivation and curtail innovation by discouraging long-term investment strategies. The study conducted by Virginia Tech researchers Jin Xu and Pengfei Ye analyses executive compensation structures’ influence on corporate decision-making, drawing on data from thousands of U.S. firms between 2006 and 2022. Their findings, published in the Journal of Financial and Quantitative Analysis, suggest that a system meant to align executive interests with shareholder value might, paradoxically, weaken that alignment.
The crux of the issue lies in how value-based equity grants function. Under this model, CEOs are awarded stock compensation tied to a fixed monetary value rather than a fixed number of shares. If a company’s stock price rises, the executive receives fewer shares; conversely, if the stock price falls, they receive more. While this approach offers a stable and predictable compensation framework, it significantly caps the potential upside for executives. As a result, CEOs have less incentive to pursue bold, high-return strategies that could drive long-term shareholder value. “Boards of directors often aim to balance retention with risk management,” explains Xu, an associate professor at Virginia Tech’s Pamplin College of Business, “but our findings show that value-based equity grants can backfire. These grants may unintentionally discourage executives from making bold, long-term investments.”
To contextualise this, the study contrasts value-based grants with share-based grants, where a fixed number of shares is awarded irrespective of market price. In the latter scenario, executives directly benefit when stock prices climb — the higher the value, the greater the personal reward. Proponents argue that this model encourages executives to aim for ambitious performance targets. By contrast, value-based grants disincentivise exceptional performance by scaling down share allocations when prices are high. “Under value-based compensation,” notes Ye, assistant professor at the Pamplin College of Business, “stronger stock performance actually results in fewer shares for executives. That weakens the reward for driving long-term gains.” The research finds a clear correlation: firms employing value-based grants consistently invest less in research and development, a primary engine of innovation and future growth.
The study also interrogates the assumption that robust corporate governance can mitigate the drawbacks of flawed pay structures. Xu and Ye measured governance strength through established firm-level metrics and compared innovation spending across companies with varying levels of board oversight. The results were striking. Value-based pay schemes undermine CEO innovation incentives even in firms with strong governance frameworks. Companies most likely to adopt value-based compensation often have more sophisticated internal controls. Yet, these controls proved insufficient in countering the disincentive effects inherent in the compensation model. “Good governance can prevent many executive pay abuses,” Xu remarked, “but it does not completely fix the disincentives created by value-based equity grants.”
Over the past two decades, value-based compensation has become increasingly prevalent. In 2006, approximately 60 per cent of firms used value-based equity grants; by 2022, that number had risen to 73 per cent. Meanwhile, the proportion of firms using traditional share-based compensation fell from 40 per cent to just 27 per cent. This shift suggests a broader corporate America trend favouring compensation predictability and executive retention over performance-driven incentives. While such an approach can provide short-term stability and protect companies from excessive risk, it may ultimately hinder strategic leadership and long-term growth. “As more firms adopt value-based pay,” Ye warned, “they need to recognise the long-term trade-offs. A growing reliance on this model could mean lower innovation and slower corporate growth.”
At the heart of the debate lies a fundamental tension: the challenge of balancing retention with leadership dynamism. Value-based pay offers stability by reducing executive earnings volatility, making retaining top talent easier. However, as Xu and Ye demonstrate, the trade-off is a diminished appetite for risk and a hesitancy to pursue transformative initiatives. The researchers argue that these outcomes are not merely theoretical concerns but have measurable impacts on company performance and investment patterns. “Retention and strategic incentives should not be at odds with each other,” Xu contends. “Boards need to design compensation models that keep top talent and push them to drive sustained company growth.” One potential solution is adopting hybrid models incorporating both share-based and value-based compensation elements, thus preserving stability while reinvigorating the incentive to innovate.
For investors and board members alike, the study underscores an urgent need for critical reflection on the strategic implications of executive pay. Compensation structures are more than just financial mechanisms — they are levers that shape corporate behaviour and long-term planning. Investors should scrutinise how much CEOs are paid and how they are paid, as this can reveal much about a firm’s future trajectory. Companies relying on value-based grants may prioritise cautious, incremental strategies over bold leadership, potentially compromising their competitive edge. “As executive pay continues to evolve,” Ye concludes, “investors should take a closer look at the structure behind the numbers. Executive compensation isn’t just about figures — it’s about the strategy that underpins them.” This study provides compelling evidence that thoughtful, well-calibrated remuneration frameworks are essential for fostering innovation and sustainable growth.
More information: Jin Xu et al, Value-Based CEO Equity Grants, Journal of Financial and Quantitative Analysis. DOI: 10.1017/S0022109025000018
Journal information: Journal of Financial and Quantitative Analysis Provided by Virginia Tech