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Dynamic CEO compensation

Journal

Journal of Finance

Subject

Finance

Publishing details

Journal of Finance 2012 Vol 67:5 p 1603-1647

Authors / Editors

Edmans A;Gabaix X;Sadzik T;Sannikov Y

Biographies

Alex Edmans

Publication Year

2012

Abstract

We study optimal compensation in a dynamic framework where the CEO consumes in multiple periods, can undo the contract by privately saving, and can temporarily inflate earnings. We obtain a simple closed-form contract that yields clear predictions for how the level and performance sensitivity of pay vary over time and across firms. The contract can be implemented by escrowing the CEO’s pay into a “Dynamic Incentive Account” that comprises cash and the firm’s equity. The account features state-dependent rebalancing to ensure its equity proportion is always sufficient to induce effort, and time-dependent vesting to deter short-termism.

Publication Research Centre

Institute of Finance and Accounting

Available on ECCH

No


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