On the valuation and incentive effects of executive cash bonus contracts
AbstractExecutive compensation packages are often valued in an inconsistent manner: while employee stock options (ESOs) are typically valued ex-ante, cash bonuses are valued ex-post. This renders the existing valuation models of employee compensation packages theoretically unsatisfactory and, potentially, empirically distortive. In this paper, we propose an option-based framework for ex-ante valuation of cash bonus contracts. After obtaining closed-form expressions for ex-ante values of several frequently used types of bonus contracts, we utilize them to explore the e¤ects that the shape of a bonus contract has on the executive’s attitude toward risk-taking. We, also, study pay-performance sensitivity of such contracts. We show that the terms of a bonus contract can dramatically impact both risk-taking behavior as well as pay-performance incentives. Several testable predictions are made, and venues of future research outlined.
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Bibliographic InfoPaper provided by Department of Economics and Business, Universitat Pompeu Fabra in its series Economics Working Papers with number 784.
Date of creation: Dec 2003
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Executive compensation; cash bonus; incentives; risk-taking behavior;
Find related papers by JEL classification:
- J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
This paper has been announced in the following NEP Reports:
- NEP-ALL-2004-12-12 (All new papers)
- NEP-BEC-2004-12-12 (Business Economics)
- NEP-LAB-2004-12-12 (Labour Economics)
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