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Pay-for-(Persistent)-Luck: CEO Bonuses Under Relational and Formal Contracting

  • Jed DeVaro

    (California State University)

  • Jin-Hyuk Kim

    (University of Colorado at Boulder)

  • Nick Vikander

    (Department of Economics, Copenhagen University)

This study investigates the structure of optimal incentives in a stochastic environment and provides evidence for the use of self-enforcing relational contracts. We show theoretically that under relational contracting, firms can credibly promise chief executive officers (CEOs) larger bonuses in good states than in bad, in a way that depends crucially on the state's persistence and the firm's discount factor. Formal contracting instead implies the same bonus in both states. Estimating an empirical model using ExecuComp data, we find that CEO annual bonuses are related to "luck" in a manner consistent with relational contracting.

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Paper provided by University of Copenhagen. Department of Economics in its series Discussion Papers with number 14-13.

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Length: 48 pages
Date of creation: 08 Apr 2014
Date of revision:
Handle: RePEc:kud:kuiedp:1413
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