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Sticks or Carrots? Optimal CEO Compensation when Managers Are Loss Averse

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  • INGOLF DITTMANN
  • ERNST MAUG
  • OLIVER SPALT

Abstract

This paper analyzes optimal executive compensation contracts when managers are loss averse. We calibrate a stylized principal-agent model to the observed contracts of 595 CEOs and show that this model can explain observed option holdings and high base salaries remarkably well for a range of parameterizations. We also derive and calibrate the general shape of the optimal contract that is increasing and convex for medium and high outcomes and that drops discontinuously to the lowest possible payout for low outcomes. Finally, we identify the critical features of the loss-aversion model that render optimal contracts convex. Copyright (c) 2010 the American Finance Association.

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Bibliographic Info

Article provided by American Finance Association in its journal The Journal of Finance.

Volume (Year): 65 (2010)
Issue (Month): 6 (December)
Pages: 2015-2050

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Handle: RePEc:bla:jfinan:v:65:y:2010:i:6:p:2015-2050

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Cited by:
  1. Pierre Chaigneau, 2012. "Explaining the Structure of CEO Incentive Pay with Decreasing Relative Risk Aversion," Cahiers de recherche 1208, CIRPEE.
  2. Peters, Hans, 2012. "A preference foundation for constant loss aversion," Journal of Mathematical Economics, Elsevier, vol. 48(1), pages 21-25.
  3. Grout, Paul A. & Zalewska, Anna, 2012. "The effect of option granting on executive stock purchases," Economics Letters, Elsevier, vol. 114(1), pages 12-15.
  4. Pierre Chaigneau & Nicolas Sahuguet, 2012. "Pay-for-Luck in CEO Compensation: Matching and Efficient Contracting," Cahiers de recherche 1224, CIRPEE.
  5. Eliaz, Kfir & Spiegler, Rani, 2012. "Reference Dependence and Labor-Market Fluctuations," CEPR Discussion Papers 8997, C.E.P.R. Discussion Papers.
  6. Bahaji, Hamza, 2012. "Cumulative Prospect Theory, employee exercise behaviour and stock options cost assessment," Economics Papers from University Paris Dauphine 123456789/9550, Paris Dauphine University.
  7. Pierre Chaigneau, 2011. "Explaining the Structure of CEO Incentive Pay with Decreasing Relative Risk Aversion," FMG Discussion Papers, Financial Markets Group dp693, Financial Markets Group.
  8. Hongfei Tang, 2014. "Are CEO stock option grants optimal? Evidence from family firms and non-family firms around the Sarbanes–Oxley Act," Review of Quantitative Finance and Accounting, Springer, vol. 42(2), pages 251-292, February.
  9. Hamza Bahaji, 2011. "Employee Stock Options Incentive Effects: A Cpt-Based Model," Working Papers halshs-00618477, HAL.
  10. Pierre Chaigneau, 2012. "The Effect of Risk Preferences on the Valuation and Incentives of Compensation Contracts," Cahiers de recherche 1209, CIRPEE.
  11. Pierre Chaigneau, 2012. "The Optimal Timing of CEO Compensation," Cahiers de recherche 1207, CIRPEE.
  12. Taylor, Lucian A., 2013. "CEO wage dynamics: Estimates from a learning model," Journal of Financial Economics, Elsevier, Elsevier, vol. 108(1), pages 79-98.
  13. Pierre Chaigneau, 2012. "The effect of risk preferences on the valuation and incentives of compensation contracts," FMG Discussion Papers, Financial Markets Group dp697, Financial Markets Group.
  14. Müller, Helge & Schumacher, Christoph & Feess, Eberhard, 2011. "Gender behavior in betting markets," Annual Conference 2011 (Frankfurt, Main): The Order of the World Economy - Lessons from the Crisis 48697, Verein für Socialpolitik / German Economic Association.
  15. Dittmann, Ingolf & Maug, Ernst & Zhang, Dan, 2011. "Restricting CEO pay," Journal of Corporate Finance, Elsevier, Elsevier, vol. 17(4), pages 1200-1220, September.
  16. Hayes, Rachel M. & Lemmon, Michael & Qiu, Mingming, 2012. "Stock options and managerial incentives for risk taking: Evidence from FAS 123R," Journal of Financial Economics, Elsevier, Elsevier, vol. 105(1), pages 174-190.
  17. Bahaji, Hamza, 2014. "Are Employee Stock Option Exercise Decisions Better Explained through the Prospect Theory?," Economics Papers from University Paris Dauphine 123456789/13098, Paris Dauphine University.
  18. Chaigneau, Pierre, 2013. "Explaining the structure of CEO incentive pay with decreasing relative risk aversion," Journal of Economics and Business, Elsevier, Elsevier, vol. 67(C), pages 4-23.

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