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Stock-Based Compensation and CEO (Dis)Incentives

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  • Efraim Benmelech
  • Eugene Kandel
  • Pietro Veronesi

Abstract

Stock-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 over-valued 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 Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 13732.

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Date of creation: Jan 2008
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Publication status: published as Efraim Benmelech & Eugene Kandel & Pietro Veronesi, 2010. "Stock-Based Compensation and CEO (Dis)Incentives," The Quarterly Journal of Economics, MIT Press, vol. 125(4), pages 1769-1820, November.
Handle: RePEc:nbr:nberwo:13732

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Citations

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Cited by:
  1. Alessandra Bonfiglioli & Gino Gancia, 2009. "Growth, selection and appropriate contracts," Economics Working Papers 1345, Department of Economics and Business, Universitat Pompeu Fabra, revised Jul 2012.
  2. Carola Frydman & Dirk Jenter, 2010. "CEO Compensation," CESifo Working Paper Series 3277, CESifo Group Munich.
  3. Robert Jones & Yan Wu, 2010. "Executive compensation, earnings management and shareholder litigation," Review of Quantitative Finance and Accounting, Springer, vol. 35(1), pages 1-20, July.
  4. Siegert, Caspar, 2014. "Bonuses and managerial misbehaviour," European Economic Review, Elsevier, vol. 68(C), pages 93-105.
  5. : Panayiotis C. Andreou & : Constantinos Antoniou & : Joanne Horton & : Christodoulos Louca, 2013. "Corporate Governance and Firm-Specific stock Price Crashes," Working Papers wpn13-06, Warwick Business School, Finance Group.
  6. Giannetti, Mariassunta, 2007. "Serial CEO Incentives and the Structure of Managerial Contracts," CEPR Discussion Papers 6422, C.E.P.R. Discussion Papers.
  7. Peng, Lin & Röell, Ailsa A, 2009. "Managerial Incentives and Stock Price Manipulation," CEPR Discussion Papers 7442, C.E.P.R. Discussion Papers.
  8. Jeong-Bon Kim & Li Li & Mary L. Z. Ma & Frank M. Song, 2013. "CEO Option Compensation, Risk-Taking Incentives, and Systemic Risk in the Banking Industry," Working Papers 182013, Hong Kong Institute for Monetary Research.
  9. Alex Edmans & Vivian W. Fang & Katharina A. Lewellen, 2013. "Equity Vesting and Managerial Myopia," NBER Working Papers 19407, National Bureau of Economic Research, Inc.
  10. Kim, Jeong-Bon & Li, Yinghua & Zhang, Liandong, 2011. "CFOs versus CEOs: Equity incentives and crashes," Journal of Financial Economics, Elsevier, vol. 101(3), pages 713-730, September.
  11. Xu, Nianhang & Li, Xiaorong & Yuan, Qingbo & Chan, Kam C., 2014. "Excess perks and stock price crash risk: Evidence from China," Journal of Corporate Finance, Elsevier, vol. 25(C), pages 419-434.

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