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Stock Grants As a Commitment Device

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  • Clementi, Gian Luca
  • Cooley, Thomas F.
  • Wang, Cheng

Abstract

A large and increasing fraction of the value of executives' compensation is accounted for by security grants. However, in most models of executive compensation, the optimal allocation can be implemented through a sequence of state-contingent cash payments. Security awards are redundant. In this paper we develop a dynamic model of managerial compensation where neither the firm nor the manager can commit to long-term contracts. We show that, in this environment, if stock grants are not used, then the optimal contract collapses to a series of short term contracts. When stock grants are used, however, nonlinear intertemporal schemes can be implemented to achieve better risk-sharing and higher firm value.

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Bibliographic Info

Paper provided by Iowa State University, Department of Economics in its series Staff General Research Papers with number 12300.

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Date of creation: 01 Nov 2006
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Publication status: Published in Journal of Economic Dynamics and Control, November 2006, vol. 30 no. 11, pp. 2191-2216
Handle: RePEc:isu:genres:12300

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Postal: Iowa State University, Dept. of Economics, 260 Heady Hall, Ames, IA 50011-1070
Phone: +1 515.294.6741
Fax: +1 515.294.0221
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Web page: http://www.econ.iastate.edu
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References

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  1. Gian Luca Clementi & Thomas F. Cooley, . "Sensitivity of CEO Pay to Shareholder Wealth in a Dynamic Agency Model," GSIA Working Papers 2002-E13, Carnegie Mellon University, Tepper School of Business.
  2. Jorge Aseff & Manuel Santos, 2005. "Stock options and managerial optimal contracts," Economic Theory, Springer, vol. 26(4), pages 813-837, November.
  3. Phelan Christopher, 1995. "Repeated Moral Hazard and One-Sided Commitment," Journal of Economic Theory, Elsevier, vol. 66(2), pages 488-506, August.
  4. Haubrich, Joseph G, 1994. "Risk Aversion, Performance Pay, and the Principal-Agent Problem," Journal of Political Economy, University of Chicago Press, vol. 102(2), pages 258-76, April.
  5. Toshihiko Mukoyama & Ayşegül Şahin, 2005. "Repeated moral hazard with persistence," Economic Theory, Springer, vol. 25(4), pages 831-854, 06.
  6. Wang, Cheng, 1997. "Incentives, CEO Compensation and Shareholder Wealth in a Dynamic Agency Model," Staff General Research Papers 5170, Iowa State University, Department of Economics.
  7. Kocherlakota, Narayana R, 1996. "Implications of Efficient Risk Sharing without Commitment," Review of Economic Studies, Wiley Blackwell, vol. 63(4), pages 595-609, October.
  8. Viral Acharya & Kose John & Rangarajan K. Sundaram, 1999. "On the Optimality of Resetting Executive Stock Options," New York University, Leonard N. Stern School Finance Department Working Paper Seires 99-087, New York University, Leonard N. Stern School of Business-.
  9. Andrei Shleifer & Lawrence H. Summers, 1987. "Breach of Trust in Hostile Takeovers," NBER Working Papers 2342, National Bureau of Economic Research, Inc.
  10. Garen, John E, 1994. "Executive Compensation and Principal-Agent Theory," Journal of Political Economy, University of Chicago Press, vol. 102(6), pages 1175-99, December.
  11. Wang, Cheng, 1997. "Incentives, CEO Compensation, and Shareholder Wealth in a Dynamic Agency Model," Journal of Economic Theory, Elsevier, vol. 76(1), pages 72-105, September.
  12. Jennifer N. Carpenter, 2000. "Does Option Compensation Increase Managerial Risk Appetite?," Journal of Finance, American Finance Association, vol. 55(5), pages 2311-2331, October.
  13. Thomas, Jonathan & Worrall, Tim, 1988. "Self-enforcing Wage Contracts," Review of Economic Studies, Wiley Blackwell, vol. 55(4), pages 541-54, October.
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Cited by:
  1. M. Imtiaz Mazumder & Nazneen Ahmad, 2010. "Greed, financial innovation or laxity of regulation?: A close look into the 2007-2009 financial crisis and stock market volatility," Studies in Economics and Finance, Emerald Group Publishing, vol. 27(2), pages 110-134, June.
  2. Lustig, Hanno & Syverson, Chad & Van Nieuwerburgh, Stijn, 2011. "Technological change and the growing inequality in managerial compensation," Journal of Financial Economics, Elsevier, vol. 99(3), pages 601-627, March.
  3. Vincenzo Quadrini & Ramon Marimon & Thomas Cooley, 2012. "Risky Investments with Limited Commitment," 2012 Meeting Papers 603, Society for Economic Dynamics.
  4. Gian Luca Clementi & Thomas F. Cooley, 2009. "Executive Compensation: Facts," NBER Working Papers 15426, National Bureau of Economic Research, Inc.
  5. Arantxa Jarque, 2008. "Optimal CEO compensation and stock options," Working Papers. Serie EC 2008-04, Instituto Valenciano de Investigaciones Económicas, S.A. (Ivie).
  6. Antonio Mele, 2008. "Repeated Moral Hazard and Recursive Lagrangeans," 2008 Meeting Papers 482, Society for Economic Dynamics.
  7. Arantxa Jarque, 2008. "CEO compensation : trends, market changes, and regulation," Economic Quarterly, Federal Reserve Bank of Richmond, issue Sum, pages 265-300.

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