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

Author Info

  • Jed DeVaro

    (California State University)

  • Jin-Hyuk Kim

    (University of Colorado at Boulder)

  • Nick Vikander

    (Department of Economics, Copenhagen University)

Abstract

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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Keywords: relational contracts; CEO compensation; pay-for-luck;

Find related papers by JEL classification:

  • C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games
  • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
  • J41 - Labor and Demographic Economics - - Particular Labor Markets - - - Labor Contracts

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  1. Merton, Robert C., 1973. "On the pricing of corporate debt: the risk structure of interest rates," Working papers 684-73., Massachusetts Institute of Technology (MIT), Sloan School of Management.
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  8. Zvika Afik & Ohad Arad & Koresh Galil, 2012. "Using Merton model: an empirical assessment of alternatives," Working Papers 1202, Ben-Gurion University of the Negev, Department of Economics.
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  10. Bebchuk, Lucian Arye & Fried, Jesse, 2003. "Executive Compensation as an Agency Problem," CEPR Discussion Papers 3961, C.E.P.R. Discussion Papers.
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  17. Huanxing Yang, 2013. "Nonstationary Relational Contracts With Adverse Selection," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 54(2), pages 525-547, 05.
  18. John E. Core & Wayne R. Guay & David F. Larcker, 2003. "Executive equity compensation and incentives: a survey," Economic Policy Review, Federal Reserve Bank of New York, issue Apr, pages 27-50.
  19. Bebchuk, Lucian A. & Fried, Jesse M., 2003. "Executive Compensation as an Agency Problem," Berkeley Olin Program in Law & Economics, Working Paper Series qt81q3136r, Berkeley Olin Program in Law & Economics.
  20. Steven Shavell, 1979. "Risk Sharing and Incentives in the Principal and Agent Relationship," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 55-73, Spring.
  21. Hallock, Kevin F. & Oyer, Paul, 1999. "The timeliness of performance information in determining executive compensation," Journal of Corporate Finance, Elsevier, vol. 5(4), pages 303-321, December.
  22. Colin Camerer & Sera Linardi, 2010. "Can Relational Contracts Survive Stochastic Interruptions? Experimental Evidence," Working Papers 483, University of Pittsburgh, Department of Economics, revised Mar 2012.
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