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Stock-Based Compensation and CEO (Dis)Incentives

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  • Benmelech, Effi
  • Kandel, Eugene
  • Veronesi, Pietro

Abstract

Stock-based compensation is the standard solution to agency problems between shareholders and managers. In a dynamic rational expectations equilibrium model with asymmetric information we show that although stock-based compensation causes managers to work harder, it also induces them to hide any worsening of the firm’s investment opportunities by following largely sub-optimal investment policies. This problem is especially severe for growth firms, whose stock prices then become overvalued while managers hide the bad news to shareholders. We find that a firm-specific compensation package based on both stock and earnings performance instead induces a combination of high effort, truth revelation and optimal investments. The model produces numerous predictions that are consistent with the empirical evidence.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 6515.

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Date of creation: Oct 2007
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Handle: RePEc:cpr:ceprdp:6515

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Keywords: CEO compensation; Sub-optimal investments;

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References

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  1. Patrick Bolton & José Scheinkman & Wei Xiong, 2006. "Executive Compensation and Short-Termist Behaviour in Speculative Markets," Review of Economic Studies, Oxford University Press, vol. 73(3), pages 577-610.
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  17. Eisfeldt, Andrea L. & Rampini, Adriano A., 2008. "Managerial incentives, capital reallocation, and the business cycle," Journal of Financial Economics, Elsevier, vol. 87(1), pages 177-199, January.
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Cited by:
  1. Alessandra Bonfiglioli & Gino Gancia, 2011. "Growth, Selection and Appropriate Contracts," UFAE and IAE Working Papers 876.11, Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC), revised 05 Oct 2012.
  2. Carola Frydman & Dirk Jenter, 2010. "CEO Compensation," Annual Review of Financial Economics, Annual Reviews, vol. 2(1), pages 75-102, December.
  3. : Panayiotis C. Andreou & : Constantinos Antoniou & : Joanne Horton & : Christodoulos Louca, 2013. "Corporate Governance and Firm-Specific stock Price Crashes," Working Papers wpn13-06, Warwick Business School, Finance Group.
  4. Robert Jones & Yan Wu, 2010. "Executive compensation, earnings management and shareholder litigation," Review of Quantitative Finance and Accounting, Springer, vol. 35(1), pages 1-20, July.
  5. Jeong-Bon Kim & Li Li & Mary L. Z. Ma & Frank M. Song, 2013. "CEO Option Compensation, Risk-Taking Incentives, and Systemic Risk in the Banking Industry," Working Papers 182013, Hong Kong Institute for Monetary Research.
  6. Kim, Jeong-Bon & Li, Yinghua & Zhang, Liandong, 2011. "CFOs versus CEOs: Equity incentives and crashes," Journal of Financial Economics, Elsevier, vol. 101(3), pages 713-730, September.
  7. Alex Edmans & Vivian W. Fang & Katharina A. Lewellen, 2013. "Equity Vesting and Managerial Myopia," NBER Working Papers 19407, National Bureau of Economic Research, Inc.
  8. Giannetti, Mariassunta, 2011. "Serial CEO incentives and the structure of managerial contracts," Journal of Financial Intermediation, Elsevier, vol. 20(4), pages 633-662, October.
  9. Peng, Lin & Röell, Ailsa A, 2009. "Managerial Incentives and Stock Price Manipulation," CEPR Discussion Papers 7442, C.E.P.R. Discussion Papers.
  10. Xu, Nianhang & Li, Xiaorong & Yuan, Qingbo & Chan, Kam C., 2014. "Excess perks and stock price crash risk: Evidence from China," Journal of Corporate Finance, Elsevier, vol. 25(C), pages 419-434.
  11. Siegert, Caspar, 2014. "Bonuses and managerial misbehaviour," European Economic Review, Elsevier, vol. 68(C), pages 93-105.

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