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Dynamic Incentive Accounts

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  • Edmans, Alex

    (University of PA)

  • Gabaix, Xavier

    (NYU)

  • Sadzik, Tomasz

    (NYU)

  • Sannikov, Yuliy

    (Princeton University)

Abstract

We study optimal executive compensation in a dynamic framework that incorporates many important features of the CEO job absent from a static setting. Shocks to firm value may weaken the incentive effects of securities over time (e.g. drive options out of the money). The CEO can undo the contract by privately saving, and temporarily manipulate the stock price. Despite the complex setup, we obtain a simple closed-form contract. It can be implemented by a "Dynamic Incentive Account": the CEO's expected pay is escrowed into an account, a fraction of which is invested in the firm's stock and the remainder in cash. The account features state-dependent rebalancing and time-dependent vesting. If the stock price falls, cash in the account is used to buy additional shares. Unlike the repricing of options, this re-incentivization does not come for free and so the CEO is not rewarded for failure. The account vests gradually both during the CEO's employment and after he quits, to deter short-termist actions before retirement.

Suggested Citation

  • Edmans, Alex & Gabaix, Xavier & Sadzik, Tomasz & Sannikov, Yuliy, 2010. "Dynamic Incentive Accounts," Working Papers 10-19, University of Pennsylvania, Wharton School, Weiss Center.
    • Handle: RePEc:ecl:upafin:10-19
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    1. Better incentives for CEOs, and mutual fund managers, too
      by Economic Logician in Economic Logic on 2009-10-14 19:11:00

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    Cited by:

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    3. Jacek Rothert, 2015. "Monitoring, moral hazard, and turnover," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 58(2), pages 355-374, February.
    4. Selena AURELI & Federica SALVATORI, 2012. "An Investigation on Possible Links between Risk Management, Performance Measurement and Reward Schemes," Journal of Accounting and Management Information Systems, Faculty of Accounting and Management Information Systems, The Bucharest University of Economic Studies, vol. 11(3), pages 306-334, September.
    5. LiCalzi, Marco & Pavan, Alessandro, 2005. "Tilting the supply schedule to enhance competition in uniform-price auctions," European Economic Review, Elsevier, vol. 49(1), pages 227-250, January.
    6. Ingolf Dittmann & Ko-Chia Yu & Dan Zhang, 2017. "How Important Are Risk-Taking Incentives in Executive Compensation?," Review of Finance, European Finance Association, vol. 21(5), pages 1805-1846.
    7. Giannetti, Mariassunta, 2011. "Serial CEO incentives and the structure of managerial contracts," Journal of Financial Intermediation, Elsevier, vol. 20(4), pages 633-662, October.
    8. Iulia JIANU & Ionel JIANU, 2012. "The Told and Retold Story of Romanian Accounting," Journal of Accounting and Management Information Systems, Faculty of Accounting and Management Information Systems, The Bucharest University of Economic Studies, vol. 11(3), pages 391-423, September.
    9. George-Marios Angeletos & Alessandro Pavan, 2007. "Socially Optimal Coordination: Characterization and Policy Implications," Journal of the European Economic Association, MIT Press, vol. 5(2-3), pages 585-593, 04-05.
    10. Jun Yang, 2010. "Timing of Effort and Reward: Three-Sided Moral Hazard in a Continuous-Time Model," Management Science, INFORMS, vol. 56(9), pages 1568-1583, September.
    11. Kim, E. Han & Lu, Yao, 2011. "CEO ownership, external governance, and risk-taking," Journal of Financial Economics, Elsevier, vol. 102(2), pages 272-292.
    12. Daniel F. Garrett & Alessandro Pavan, 2012. "Managerial Turnover in a Changing World," Journal of Political Economy, University of Chicago Press, vol. 120(5), pages 879-925.
    13. Pierre Chaigneau, 2010. "The Optimal Timing of Executive Compensation," FMG Discussion Papers dp660, Financial Markets Group.
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    More about this item

    JEL classification:

    • D20 - Microeconomics - - Production and Organizations - - - General
    • D30 - Microeconomics - - Distribution - - - General
    • G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance
    • J30 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - General

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