Downside of Linking Executive Compensation to ROE

Hard Corporate Governance Executive Compensation

As part of its corporate governance overhaul, a mid-sized technology company announces a new executive compensation plan aimed at aligning the interests of management with shareholders. The plan introduces performance-based equity awards tied to specific metrics. After extensive analysis, the board of directors proposes that a significant portion of the equity awards be linked to the company’s return on equity (ROE) over the next three years.

Consider the implications of this decision on the overall governance of the company. What is a potential downside of linking executive compensation primarily to ROE?

It may incentivize executives to focus on short-term profitability at the expense of long-term sustainability.

It could result in executives taking on excess risk to artificially inflate ROE.

It could lead to a lack of alignment between executive pay and shareholder returns if ROE increases are achieved through capital restructuring.

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