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CEO Compensation and Strategy Inertia

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Author Info
Inderst, Roman
Mueller, Holger M
Abstract

This paper considers the joint optimal design of CEOs' on-the-job compensation and severance pay in a general optimal contracting framework. We obtain a novel argument for high-powered, non-linear CEO compensation such as bonus schemes and option grants that is different from existing arguments based on moral hazard and risk taking. Based on this argument, the CEO's optimal on-the-job compensation scheme is designed to minimize the use of costly severance pay to reduce CEO entrenchment, thus minimizing the CEO's informational rents. Our model generates novel empirical predictions concerning the interrelation of CEOs' on-the-job compensation and severance pay as well as CEO turnover which, to the extent that they have been tested, are consistent with the empirical evidence.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 5713.

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Date of creation: Jun 2006
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Handle: RePEc:cpr:ceprdp:5713

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Related research
Keywords: CEO compensation entrenchment stock options

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Find related papers by JEL classification:
D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information
D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance

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