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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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  1. Xavier Gabaix & Augustin Landier, 2006. "Why Has CEO Pay Increased So Much?," NBER Working Papers 12365, National Bureau of Economic Research, Inc.
  2. Simi Kedia & Thomas Philippon, 2005. "The Economics of Fraudulent Accounting," NBER Working Papers 11573, National Bureau of Economic Research, Inc.
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  8. Murphy, Kevin J., 1999. "Executive compensation," Handbook of Labor Economics, Elsevier, in: O. Ashenfelter & D. Card (ed.), Handbook of Labor Economics, edition 1, volume 3, chapter 38, pages 2485-2563 Elsevier.
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  13. Miller, Merton H & Rock, Kevin, 1985. " Dividend Policy under Asymmetric Information," Journal of Finance, American Finance Association, American Finance Association, vol. 40(4), pages 1031-51, September.
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  15. Brian J. Hall & Kevin J. Murphy, 2003. "The Trouble with Stock Options," NBER Working Papers 9784, National Bureau of Economic Research, Inc.
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Cited by:
  1. Alessandra Bonfiglioli & Gino Gancia, 2012. "Growth, Selection and Appropriate Contracts," Working Papers 566, Barcelona Graduate School of Economics.
  2. Giannetti, Mariassunta, 2011. "Serial CEO incentives and the structure of managerial contracts," Journal of Financial Intermediation, Elsevier, Elsevier, vol. 20(4), pages 633-662, October.
  3. 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, Elsevier, vol. 25(C), pages 419-434.
  4. Robert Jones & Yan Wu, 2010. "Executive compensation, earnings management and shareholder litigation," Review of Quantitative Finance and Accounting, Springer, Springer, vol. 35(1), pages 1-20, July.
  5. 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, Hong Kong Institute for Monetary Research 182013, Hong Kong Institute for Monetary Research.
  6. Frydman, Carola & Jenter, Dirk, 2010. "CEO Compensation," Research Papers, Stanford University, Graduate School of Business 2069, Stanford University, Graduate School of Business.
  7. Siegert, Caspar, 2014. "Bonuses and managerial misbehaviour," European Economic Review, Elsevier, Elsevier, vol. 68(C), pages 93-105.
  8. Alex Edmans & Vivian W. Fang & Katharina A. Lewellen, 2013. "Equity Vesting and Managerial Myopia," NBER Working Papers 19407, National Bureau of Economic Research, Inc.
  9. Peng, Lin & Röell, Ailsa A, 2009. "Managerial Incentives and Stock Price Manipulation," CEPR Discussion Papers, C.E.P.R. Discussion Papers 7442, C.E.P.R. Discussion Papers.
  10. : Panayiotis C. Andreou & : Constantinos Antoniou & : Joanne Horton & : Christodoulos Louca, 2013. "Corporate Governance and Firm-Specific stock Price Crashes," Working Papers, Warwick Business School, Finance Group wpn13-06, Warwick Business School, Finance Group.
  11. Kim, Jeong-Bon & Li, Yinghua & Zhang, Liandong, 2011. "CFOs versus CEOs: Equity incentives and crashes," Journal of Financial Economics, Elsevier, Elsevier, vol. 101(3), pages 713-730, September.

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