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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.

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  • Ingolf Dittmann & Ernst Maug & Oliver Spalt, 2010. "Sticks or Carrots? Optimal CEO Compensation when Managers Are Loss Averse," Journal of Finance, American Finance Association, vol. 65(6), pages 2015-2050, December.
    • Handle: RePEc:bla:jfinan:v:65:y:2010:i:6:p:2015-2050
    DOI: 10.1111/j.1540-6261.2010.01609.x
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    JEL classification:

    • M52 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Personnel Economics - - - Compensation and Compensation Methods and Their Effects
    • G30 - Financial Economics - - Corporate Finance and Governance - - - General

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