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Stock grants as a commitment device

  • Clementi, Gian Luca
  • Cooley, Thomas F.
  • Wang, Cheng

A large and increasing fraction of the value of executives' compensation is accounted for by security grants. It is often argued that the optimal compensation contracts characterized in the theoretical literature can be implemented by means of stock or option grants. However, in most cases the optimal allocation can be implemented simply by a contingent sequence of cash payments. Security awards are redundant. In this paper we develop a dynamic model of managerial compensation where neither the firm nor the manager can commit to long-term contracts. We show that, in this environment, if stock grants are not used, then the optimal contract collapses to a series of short term contracts. When stock grants are used, however, nonlinear intertemporal schemes can be implemented to achieve better risk-sharing and larger firm value.

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Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 30 (2006)
Issue (Month): 11 (November)
Pages: 2191-2216

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Handle: RePEc:eee:dyncon:v:30:y:2006:i:11:p:2191-2216
Contact details of provider: Web page: http://www.elsevier.com/locate/jedc

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  9. Jennifer N. Carpenter, 2000. "Does Option Compensation Increase Managerial Risk Appetite?," Journal of Finance, American Finance Association, vol. 55(5), pages 2311-2331, October.
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  11. Narayana Kocherlakota, 2010. "Implications of Efficient Risk Sharing Without Commitment," Levine's Working Paper Archive 2053, David K. Levine.
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