Pay-for-Luck in CEO Compensation: Matching and Efficient Contracting
AbstractWe develop a stylized model of efficient contracting with matching between firms and managers with state-contingent reservation utility. We show that the optimal contract is designed to retain and insure the manager. The retention motive explains pay-for-luck in executive compensation, while the insurance feature explains asymmetric pay-for-luck. This contract can be implemented with call options based on a single performance measure which generally does not filter out luck. When costs of involuntary managerial turnover differ across firms, and the abilities of different managers are more or less precisely estimated ex-ante, the model can also explain the observed association between pay-for-luck and bad corporate governance.
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Bibliographic InfoPaper provided by CIRPEE in its series Cahiers de recherche with number 1224.
Date of creation: 2012
Date of revision:
CEO pay; corporate governance; pay-for-luck; stock-options;
Find related papers by JEL classification:
- D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
- G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance
- J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods
This paper has been announced in the following NEP Reports:
- NEP-ALL-2012-06-05 (All new papers)
- NEP-BEC-2012-06-05 (Business Economics)
- NEP-CTA-2012-06-05 (Contract Theory & Applications)
- NEP-HRM-2012-06-05 (Human Capital & Human Resource Management)
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