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Executive Compensation and the Optimality of Managerial Entrenchment

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  • Gary Gorton
  • Bruce D. Grundy

Abstract

Firms are more complicated than standard principal-agent theory allows: firms have assets-in-place; firms endure through time, allowing for the possibility of replacing a shirking manager; firms have many managers, constraining the amount of equity that can be awarded to any one manager; and, a firm's owner can transfer some control to a manager, thereby entrenching her. Recognizing these characteristics, we solve for the vesting dates; wage, equity and options components; and control rights of an optimal contract. Managerial entrenchment makes the promise of deferred compensation credible. Deferring compensation by delaying vesting reduces a manager's ability to free-ride on a replacement's effort.

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Paper provided by Wharton School Rodney L. White Center for Financial Research in its series Rodney L. White Center for Financial Research Working Papers with number 15-96.

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Handle: RePEc:fth:pennfi:15-96

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  1. Hermalin, B.E. & Weisbech, M.S., 1991. "The Effects of Board Composition and Direct Incentives on Firm Performance," Papers 91-02, Rochester, Business - Financial Research and Policy Studies.
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  4. Berglof, Erik, 1994. "A Control Theory of Venture Capital Finance," Journal of Law, Economics and Organization, Oxford University Press, vol. 10(2), pages 247-67, October.
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  8. Bizjak, John M. & Brickley, James A. & Coles, Jeffrey L., 1993. "Stock-based incentive compensation and investment behavior," Journal of Accounting and Economics, Elsevier, vol. 16(1-3), pages 349-372, April.
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  12. Mikkelson, Wayne H. & Partch, M. Megan, 1994. "The consequences of unbundling managers' voting rights and equity claims," Journal of Corporate Finance, Elsevier, vol. 1(2), pages 175-199, August.
  13. Huddart, Steven, 1994. "Employee stock options," Journal of Accounting and Economics, Elsevier, vol. 18(2), pages 207-231, September.
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Cited by:
  1. David R. Skeie, 2007. "Vesting and control in venture capital contracts," Staff Reports 297, Federal Reserve Bank of New York.
  2. Dow, James, 2013. "Boards, CEO entrenchment, and the cost of capital," Journal of Financial Economics, Elsevier, vol. 110(3), pages 680-695.

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