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Stock-Based Compensation and CEO (Dis)Incentives

Author

Listed:
  • Efraim Benmelech
  • Eugene Kandel
  • Pietro Veronesi

Abstract

The use of stock-based compensation as a solution to agency problems between shareholders and managers has increased dramatically since the early 1990s. We show that in a dynamic rational expectations model with asymmetric information, stock-based compensation not only induces managers to exert costly effort, but also induces them to conceal bad news about future growth options and to choose suboptimal investment policies to support the pretense. This leads to a severe overvaluation and a subsequent crash in the stock price. Our model produces many predictions that are consistent with the empirical evidence and are relevant to understanding the current crisis.

Suggested Citation

  • Efraim Benmelech & Eugene Kandel & Pietro Veronesi, 2010. "Stock-Based Compensation and CEO (Dis)Incentives," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 125(4), pages 1769-1820.
    • Handle: RePEc:oup:qjecon:v:125:y:2010:i:4:p:1769-1820.
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    File URL: http://hdl.handle.net/10.1162/qjec.2010.125.4.1769
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    JEL classification:

    • D2 - Microeconomics - - Production and Organizations
    • G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance
    • J3 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs

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