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Executive Compensation: The View from General Equilibrium

Author

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  • Jean-Pierre Danthine

    (University of Lausanne, CEPR and Swiss Finance Institute)

  • John B. Donaldson

    (Columbia University)

Abstract

We study the dynamic general equilibrium of an economy where risk averse shareholders delegate the management of the ¯rm to risk averse managers. The optimal contract has two main components: an incentive component corresponding to a non-tradable equity position and a variable 'salary' component indexed to the aggregate wage bill and to aggregate dividends. Tying a manager's compensation to the performance of her own ¯rm ensures that her interests are aligned with the goals of ¯rm owners and that maximizing the discounted sum of future dividends will be her objective. Linking managers' compensation to overall economic performance is also required to make sure that managers use the appropriate stochastic discount factor to value those future dividends.

Suggested Citation

  • Jean-Pierre Danthine & John B. Donaldson, 2007. "Executive Compensation: The View from General Equilibrium," Swiss Finance Institute Research Paper Series 07-33, Swiss Finance Institute.
    • Handle: RePEc:chf:rpseri:rp0733
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    Keywords

    incentives; optimal contracting; stochastic discount factor;
    All these keywords.

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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