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Dynamic Incentive Accounts

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  • Edmans, Alex

    (University of PA)

  • Gabaix, Xavier

    (NYU)

  • Sadzik, Tomasz

    (NYU)

  • Sannikov, Yuliy

    (Princeton University)

Abstract

We study optimal executive compensation in a dynamic framework that incorporates many important features of the CEO job absent from a static setting. Shocks to firm value may weaken the incentive effects of securities over time (e.g. drive options out of the money). The CEO can undo the contract by privately saving, and temporarily manipulate the stock price. Despite the complex setup, we obtain a simple closed-form contract. It can be implemented by a "Dynamic Incentive Account": the CEO's expected pay is escrowed into an account, a fraction of which is invested in the firm's stock and the remainder in cash. The account features state-dependent rebalancing and time-dependent vesting. If the stock price falls, cash in the account is used to buy additional shares. Unlike the repricing of options, this re-incentivization does not come for free and so the CEO is not rewarded for failure. The account vests gradually both during the CEO's employment and after he quits, to deter short-termist actions before retirement.

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Bibliographic Info

Paper provided by University of Pennsylvania, Wharton School, Weiss Center in its series Working Papers with number 10-19.

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Date of creation: May 2010
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Handle: RePEc:ecl:upafin:10-19

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References

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  1. Better incentives for CEOs, and mutual fund managers, too
    by Economic Logician in Economic Logic on 2009-10-14 14:11:00
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Cited by:
  1. Xavier Gabaix & Alex Edmans, 2010. "Tractability in Incentive Contracting," 2010 Meeting Papers 1120, Society for Economic Dynamics.
  2. Alex Gershkov & Motty Perry, 2012. "Dynamic Contracts with Moral Hazard and Adverse Selection," Review of Economic Studies, Oxford University Press, vol. 79(1), pages 268-306.
  3. Kim, E. Han & Lu, Yao, 2011. "CEO ownership, external governance, and risk-taking," Journal of Financial Economics, Elsevier, vol. 102(2), pages 272-292.
  4. Marco LiCalzi & Alessandro Pavan, 2003. "Tilting the Supply Schedule to Enhance Competition in Uniform-Price Auctions," Working Papers 2003.22, Fondazione Eni Enrico Mattei.
  5. Daniel F. Garrett & Alessandro Pavan, 2012. "Managerial Turnover in a Changing World," Journal of Political Economy, University of Chicago Press, vol. 120(5), pages 879 - 925.
  6. George-Marios Angeletos & Alessandro Pavan, 2006. "Socially Optimal Coordination: Characterization and Policy Implications," NBER Working Papers 12778, National Bureau of Economic Research, Inc.
  7. Pierre Chaigneau, 2010. "The Optimal Timing of Executive Compensation," FMG Discussion Papers dp660, Financial Markets Group.
  8. Giannetti, Mariassunta, 2007. "Serial CEO Incentives and the Structure of Managerial Contracts," CEPR Discussion Papers 6422, C.E.P.R. Discussion Papers.
  9. He, Zhiguo, 2011. "A model of dynamic compensation and capital structure," Journal of Financial Economics, Elsevier, vol. 100(2), pages 351-366, May.
  10. Jacek Rothert, 2009. "Monitoring, Moral Hazard and Turnover," Department of Economics Working Papers 130124, The University of Texas at Austin, Department of Economics, revised Sep 2012.
  11. Bhagat, Sanjai & Bolton, Brian, 2014. "Financial crisis and bank executive incentive compensation," Journal of Corporate Finance, Elsevier, vol. 25(C), pages 313-341.
  12. Ingolf Dittmann & Ko-Chia Yu, 2009. "How Important Are Risk-Taking Incentives in Executive Compensation?," Tinbergen Institute Discussion Papers 09-076/2, Tinbergen Institute.

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