With equity-based compensation becoming increasingly prevalent below senior management level in companies, a recent study looked at the relationship between equity-based employee incentives and cross-business-unit collaboration in multi-business companies. The results indicate that providing more junior level managers with equity incentives, in addition to profit-based incentive compensation, can elicit higher collaboration. The findings also suggest that equity-based incentives are generally of greater benefit to large companies in high-growth sectors, for companies chasing a related diversification strategy, and in stock market growth periods.
Key Topics: Equity; Long term incentives; Collaboration; Teamwork
Title of Reviewed Article: Equity-based incentives and collaboration in the modern multibusiness firm.
Researchers: Joanne Oxley (University of Toronto) and Gurupdesh Pandher (University of Windsor).
Publication: Strategic Management Journal, 2016, Vol. 37 No. 7, pp. 1379-1394.
Setting the Scene
One of the primary changes in the compensation structure of management in recent decades is the significant increase in the use of equity-based compensation for managers below the C-suite, such as stock options and restricted stock grants (Ofek & Yermack, 2000). It has been a long held belief that equity-based compensation helps align managerial incentives to shareholder demands (e.g. Holmstrom, 1979).
There is a wealth of research indicating the need for decentralized multibusiness companies to effectively balance the business unit efforts with cross-business unit efforts and collaboration (Chandler, 1977; Milgrom & Roberts, 1992). Much of the research has focused on incentive misalignment, which has been shown to create issues such as the reduction of company performance, undermining collaboration, and reduction of management effort (e.g. Holmstrom & Milgrom, 1991).
Despite the increasing relevance of equity-based compensation, there is limited and mixed research in relation to how having it as an element of managers’ total compensation impacts on teamwork and collaboration efforts. This study looks to address that gap by developing a theoretical model examining the relationship in a decentralized multibusiness company. On the one hand research suggests that basing at least part of managerial compensation on company performance encourages collaboration (e.g. Rivkin & Siggelkow, 2006), while other research argues that incentives related to companywide performance can lead to reduction in local business unit performance (Helfat & Eisenhardt, 2004), and that such global focus of incentives leads to these employees having to bear the financial risk of their performance as well as the performance of others (Baker, 2002).
How the research was conducted
For this study, the researchers developed a theoretical model in which multibusiness companies offer incentives based on company equity, business-unit profits, and total company profits to business-unit managers, in an attempt to maximize total company returns.
For the purposes of the model, the researchers consider a multibusiness company was one comprising of two symmetric business units.
Key Research Findings
Analysis found that the effort of managers was greater when they received an equity incentive for growth and productivity measures. This increased effort was found in own-business-unit effort as well as in cross–business-unit collaborative effort, and was over and above the effort effects observed with profit-only type incentives.
Highlighting some nuances relating to equity incentive use for business-unit managers, the results indicate the power of equity incentives increases when stock market conditions are good, for companies with lower market value uncertainty, when companies are pursuing a related diversification strategy, and for larger companies in high-growth sectors.
The results of this model are consistent with the findings of previous research (e.g. (Murphy, 2003) which indicated that business-wide incentives can generate cross–business-unit collaboration, and the current study adds to that research by further demonstrating that assigning equity to managers is an effective way of balancing the need to business unit specific effort and the need for company-wide collaborative teamwork among business-unit managers.
The researchers suggest that the finding that manager effort is greater when they receive equity incentives is due to manager equity incentives helping to align managers’ incentives with the company’s objectives and creates an optimal level of own–unit and cross–unit collaborative effort. For this reason, the researchers posit that such incentives will become increasingly prevalent, as companies discover the value of them.
Organizational and Reward Implications
This study lends strong support for the benefits of multibusiness companies using equity to incentivize managers towards greater teamwork and collaboration. The model developed by these researchers suggests that adding this method of compensation can increase performance of managers in these areas. This should be of particular interest to multibusiness companies where collaboration between businesses is of high importance for success.
Research has been slow to examine the phenomenon of equity based incentives being an increasingly common part of managers’ compensation package. This study goes some way in developing our understanding of how such equity can impact collaboration in multibusiness companies. While providing valuable insights, it must be acknowledged that the researchers have developed a theoretical model and further more applied research is needed to fully validate its conclusions.
Source Article: Oxley, J., & Pandher, G. (2016). Equity-based incentives and collaboration in the modern multibusiness firm. Strategic Management Journal, 37(7), 1379-1394.
Published by: John Wiley & Sons, Ltd.
For further details and access to the full journal article Click Here (subscription or payment may be required).
Baker, G. (2002). Distortion and risk in optimal incentive contracts. Journal of Human Resources,37(4), 728–751.
Chandler, A. (1977). The Visible Hand: The Managerial Revolution in American Business. Cambridge, MA: Harvard University Press.
Helfat, C. E., & Eisenhardt, K. M. (2004). Inter–temporal economies of scope, organizational modularity, and the dynamics of diversification. Strategic Management Journal, 25(13), 1217–1232.
Holmstrom, B. (1979). Moral hazard and observability. Bell Journal of Economics, 10(1), 74–91.
Holmstrom, B., & Milgrom, P. (1991). Multi-task principal agent analysis: linear contracts, asset owner ship and job design. Journal of Law, Economics, and Organization, 7, 24–52.
Milgrom, P., & Roberts, J. (1992). Economics, Organization, and Management. Englewood Cliffs, NJ: Prentice Hall.
Ofek, E., & Yermack, D. (2000). Taking stock: equity-based compensation and the evolution of managerial ownership. Journal of Finance, 55(3), 1367–1384.
Rivkin, J. W., & Siggelkow, N. (2006). Organizing to strategize in the face of interactions: preventing premature lock–in. Long Range Planning, 39, 591–614.
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