Incentive Pay that Causes Inefficient Managerial Replacement
Abstractã€€ã€€ Using contract theory, this article considers the effect of stock-based compensation on managerial replacement. I show that while stock-based compensation solves the moral hazard problem, it creates a distortion in the principal's managerial replacement decisions. Specifically, I show the principal endogenously determines the agent's tenure in a way that maximizes her own expected payoff, where her rational choice to replace or retain the incumbent agent may depart from the total firm value maximization. I find that along the parametric range of control benefit, both long- and short-term vested stock options may exhibit over-replacement of the incumbent agent, but in some cases, long-term vested options may cause more ineÂ¢ ciency than short-term vested options. The article also indicates that only the short-term vested options may exhibit under-replacement. Journal of Economic Literature Classifications:
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Bibliographic InfoPaper provided by CIRJE, Faculty of Economics, University of Tokyo in its series CIRJE F-Series with number CIRJE-F-890.
Length: 47 pages
Date of creation: Jun 2013
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This paper has been announced in the following NEP Reports:
- NEP-ALL-2013-07-05 (All new papers)
- NEP-CTA-2013-07-05 (Contract Theory & Applications)
- NEP-HRM-2013-07-05 (Human Capital & Human Resource Management)
- NEP-LMA-2013-07-05 (Labor Markets - Supply, Demand, & Wages)
- NEP-PPM-2013-07-05 (Project, Program & Portfolio Management)
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