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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. John McMillan & Christopher Woodruff, 1999. "Interfirm Relationships and Informal Credit in Vietnam," The Quarterly Journal of Economics, Oxford University Press, vol. 114(4), pages 1285-1320.
  2. Lucian Arye Bebchuk & Jesse M. Fried, 2003. "Executive Compensation as an Agency Problem," NBER Working Papers 9813, National Bureau of Economic Research, Inc.
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  13. Blanchard, Olivier Jean & Lopez-de-Silanes, Florencio & Shleifer, Andrei, 1994. "What do firms do with cash windfalls?," Journal of Financial Economics, Elsevier, vol. 36(3), pages 337-360, December.
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  16. Matthias Fahn & Valeria Merlo & Georg Wamser, 2014. "The Commitment Role of Equity Financing," CESifo Working Paper Series 4841, CESifo Group Munich.
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  18. repec:pit:wpaper:483 is not listed on IDEAS
  19. Garvey, Gerald T. & Milbourn, Todd T., 2006. "Asymmetric benchmarking in compensation: Executives are rewarded for good luck but not penalized for bad," Journal of Financial Economics, Elsevier, vol. 82(1), pages 197-225, October.
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  22. 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.
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