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To understand executive incentives and executive pay, it is vital to look at wealth, not just annual pay; measure the value of stock and options to executives who are largely undiversified; and measure the sensitivity of executive wealth to controllable changes in shareholder wealth, such as shareholder return net of market and industry factors. Employing a wealth leverage measure quantifies the strength of the incentive and provides the basis for determining the impact of stronger incentives on firm performance and assessing whether the increase in shareholder wealth from the stronger incentive is sufficient to offset the cost of the compensation premium needed to control retention risk.
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