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Tunnel-Proofing the Executive Suite: Transparency, Temptation, and the Design of Executive Compensation

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  • Thomas H. Noe

Abstract

This paper considers optimal compensation for a CEO who is entrusted with administering corporate assets honestly. Optimal compensation designs maximize integrity at minimum cost. These designs are very "low powered," i.e., while specifying a lower bound for performance and increasing pay with performance, they increase compensation at a rapidly decreasing rate. Thus, integrity considerations engender optimal compensation packages that closely resemble the very pervasive 80/120 bonus plans, exactly the sort of compensation that Jensen (2003) argues should compromise integrity. Under optimal designs, expected compensation increases linearly with firm size, and increases in the market/book ratio. Moreover, given optimal compensation, CEO asset diversion is limited to high market-to-book firms that have received negative productivity shocks. The Author 2009. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please email: journals.permissions@oxfordjournals.org, Oxford University Press.

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  • Thomas H. Noe, 2009. "Tunnel-Proofing the Executive Suite: Transparency, Temptation, and the Design of Executive Compensation," The Review of Financial Studies, Society for Financial Studies, vol. 22(12), pages 4849-4880, December.
    • Handle: RePEc:oup:rfinst:v:22:y:2009:i:12:p:4849-4880
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    File URL: http://hdl.handle.net/10.1093/rfs/hhp002
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    Cited by:

    1. Ng, Lilian & Sibilkov, Valeriy & Wang, Qinghai & Zaiats, Nataliya, 2011. "Does shareholder approval requirement of equity compensation plans matter?," Journal of Corporate Finance, Elsevier, vol. 17(5), pages 1510-1530.

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