Stock-Based Compensation and CEO (Dis)Incentives
AbstractStock-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 InfoPaper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 6515.
Date of creation: Oct 2007
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Other versions of this item:
- G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
- G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance
- G35 - Financial Economics - - Corporate Finance and Governance - - - Payout Policy
This paper has been announced in the following NEP Reports:
- NEP-ALL-2007-10-13 (All new papers)
- NEP-BEC-2007-10-13 (Business Economics)
- NEP-CFN-2007-10-13 (Corporate Finance)
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