Recent research highlights the influence of market structure on corporate governance and executive compensation decisions. A study in the Journal of Corporate Finance reveals that companies experiencing increased off-exchange or "dark" trading are more likely to utilize stock-based compensation for their chief executive officers (CEOs). This relationship arises not from the relative cost-effectiveness of equity but rather because dark trading enhances the informativeness of stock prices. Consequently, boards feel more confident in using these price signals as benchmarks for assessing management performance.
The analysis, covering 12,667 firm-years of U.S. public companies from 2007 to 2021, indicates that firms with higher levels of dark trading allocate approximately 10.6 percentage points more of CEO pay to stock compensation, which represents a 21% increase compared to the average across the sample. Additionally, during this timeframe, off-exchange trading volumes have increased from 23% to 28%.
These findings underscore a significant connection between trading venues and executive pay structures, suggesting that market structure impacts not only transaction costs but also the quality of price signals used by boards for compensation-related decisions. This has important implications for investment professionals, as it may influence their interpretation of pay disclosures, evaluations of governance quality, and assessments of potential regulatory impacts on market structure.
Why this story matters: The connection between market structure and executive compensation reveals potential gaps in governance that could be addressed through regulation.
Key takeaway: Increased dark trading leads to a greater reliance on stock-based CEO pay, influencing how boards assess performance.
Opposing viewpoint: Some experts argue that stock-based compensation may not necessarily align executive incentives with long-term company performance, raising concerns about reliance on market signals.
