When you buy a stock, you’re not just buying a ticker. You’re also buying into a CEO and their management team to run the business successfully. Executive compensation is the contract that defines what you’re paying them to do.
A well-designed pay structure aligns the CEO’s rewards with yours as a shareholder. A bad one? It can incentivise shortcuts, disguise poor performance, or drain value while rewarding failure. The key question isn’t “how much” an executive is paid. It’s how the pay is structured, what behaviours it rewards, and whether it reflects real performance.
Core components of executive pay
Compensation typically includes a mix of fixed and variable incentives.
1. Base salary
- Structure: Fixed annual cash payment
- Pros: Predictable; compensates for experience and leadership stability
- Cons: Unlinked to performance
🚩 Red flag: A high base salary at a consistently underperforming company suggests poor governance and entrenched leadership.
2. Annual cash bonus (short-term incentives, or STI)
- Structure: Yearly payout based on meeting short-term financial or operational goals
- Common metrics: Revenue growth, EBITDA, safety targets, customer retention
- Pros: Can drive execution of near-term objectives
- Cons: Easily gamed; may encourage short-termism
🔍 What to check: Are goals clearly disclosed? Are they adjusted down when performance is weak but not raised when conditions are strong? Are thresholds so low that payouts are nearly guaranteed?
3. Long-Term Incentives (LTI)
This is the most critical component for aligning management with long-term shareholder value. They include:
- Stock options: Gain value only if the share price rises above the grant price
- RSUs (Restricted stock units): Vest over time, usually without performance hurdles
- PSUs (Performance stock units): Vest based on meeting multi-year goals like total shareholder return (TSR) or return on capital
🔍 What to check: Are most of the LTI performance-based or just time-based retention pay? Are the targets ambitious and transparent, or vague and easily met?
4. Risk Controls
- Clawbacks: Allow the company to recover bonuses in cases of fraud or financial restatements
- Caps: Set upper limits on variable pay
- Holding periods: Require executives to retain shares post-vesting or until retirement
- Ownership guidelines: Mandate that executives maintain a minimum level of company stock, ensuring they have meaningful personal stakes in shareholder outcomes.
Practical applications
Understanding the company’s compensation structure is only helpful if you can translate it into better investment decisions. Here’s how:
1. Decode the incentives, not just the numbers
When reviewing executive compensation, it’s important to look beyond the headline figures and focus on what the pay structure actually encourages. For example, a CEO whose bonus depends heavily on revenue growth may be inclined to prioritize expansion at the expense of profitability, while one whose incentives are tied to return on invested capital is more likely to emphasize disciplined capital allocation and sustainable value creation.
Bonuses tied to adjusted EBITDA should raise questions about whether management might lean on aggressive accounting manoeuvres to meet targets. The key principle is simple: incentives drive behaviour. If an executive is compensated like a stock promoter, don’t be surprised when they act like one.
2. Interrogate the metrics
Not all performance metrics are created equal, and some do a better job than others at signalling durable value creation. Strong measures include return on invested capital (ROIC), free cash flow, and total shareholder return compared with industry peers. Weaker measures, such as revenue, adjusted EBITDA, or vague “strategic milestones,” can be easily manipulated or lack accountability.
It’s also worth auditing a company’s track record: do executives consistently meet low targets, collect bonuses despite poor returns, or shift performance metrics every year? The quality of chosen KPIs often says more about management priorities than the numbers themselves.
3. Align pay outcomes with shareholder outcomes
A useful test is to ask: If you had held the stock for the past three years, did management win when you did? This means comparing realized executive pay with stock performance and peer benchmarks, and checking whether performance-based awards were truly earned. That said, stock price alone isn’t always the best indicator. If long-term incentives were tied to margin expansion or other operational targets, those specific metrics should be evaluated directly. The goal is to ensure that pay outcomes line up with the performance criteria that matter most to long-term shareholders.
4. Compare across peers, but wisely
Peer comparisons can be revealing, but only if used carefully. Instead of simply asking whether a CEO is paid more than their counterparts, the better question is whether their pay structure is better aligned with value creation. Watch out for cherry-picked peer groups that inflate relative pay standing, or boards that benchmark against larger, more profitable companies as a way of justifying higher compensation. True comparisons require thoughtful context.
5. Ditch the “high pay = bad” shortcut
It’s a mistake to assume that high compensation is automatically a red flag. Companies like Apple, Microsoft, and Nvidia have paid their executives handsomely while also delivering outstanding returns to shareholders. The real question is whether pay and performance are tightly linked. Are bad years penalized and good years rewarded? Is there a steep pay-for-performance curve? Does the CEO buy and hold stock, or do they sell shares as soon as they vest? A persistent pattern of executives cashing out while continuing to receive equity grants suggests misalignment—an extraction mindset rather than true ownership.
Real world case studies
Macy’s Inc.
Macy’s executives were paid based on adjusted EBITDA and margin. These non-GAAP numbers were later revealed to be overstated. Bonuses had already been paid out with no real gain for shareholders.
Warner Bros. Discovery
Despite an US$11.5 billion net loss in 2024, CEO David Zaslav received US$52 million in compensation. His annual bonus awards were primarily tied to metrics like revenue, adjusted EBITDA and DTC subscriber growth, which can be easily boosted through discounting, not long-term profitability. The board prioritised optics over value.
The fifth perspective
Most investors skip the proxy statement, often put off by its dense language and technical jargon. But buried within it are some of the clearest signals of a company’s true priorities. A well-structured compensation plan won’t guarantee investment success, but it improves the odds by aligning executive incentives with shareholder value. On the other hand, a poorly designed one is one of the most reliable warning signs of long-term underperformance. It often reflects weak governance, poor capital discipline, and a management team whose interests may not match yours. So the next time you evaluate a stock, read the proxy statement. Skip it, and you’re flying blind on the most powerful influence over how your CEO is paid to act.
