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Executive Compensation and Stock Options: An Inconvenient Truth

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Author Info

  • Jean-Pierre Danthine

    (Swiss Finance Institute, University of Lausanne and CEPR)

  • John B. Donaldson

    (Columbia University)

Abstract

We reexamine the issue of executive compensation within a gen- eral equilibrium production context. Intertemporal optimality places strong restrictions on the form of a representative manager's compen- sation contract, restrictions that appear to be incompatible with the fact that the bulk of many high-proffile managers' compensation is in the form of various options and option-like rewards. We therefore measure the extent to which a convex contract alone can induce the manager to adopt near-optimal investment and hiring decisions. To ask this question is essentially to ask if such contracts can effectively align the stochastic discount factor of the manager with that of the shareholder-workers. We detail exact circumstances under which this alignment is possible and when it is not.

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Bibliographic Info

Paper provided by Swiss Finance Institute in its series Swiss Finance Institute Research Paper Series with number 08-13.

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Length: 32 pages
Date of creation: Jun 2008
Date of revision:
Handle: RePEc:chf:rpseri:rp0813

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Web page: http://www.SwissFinanceInstitute.ch
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Keywords: corporate governance; optimal contracting; business cycles;

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