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Executive Compensation: The View from General Equilibrium

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  • Jean-Pierre DANTHINE
  • John B. DONALDSON

Abstract

We study the dynamic general equilibrium of an economy where risk averse shareholders delegate the management of the firm to risk averse managers. The optimal contract has two main components: an incentive component corresponding to a non-tradable equity position and a variable 'salary' component indexed to the aggregate wage bill and to aggregate dividends. Tying a manager's compensation to the performance of her own firm ensures that her interests are aligned with the goals of firm owners and that maximizing the discounted sum of future dividends will be her objective. Linking managers' compensation to overall economic performance is also required to make sure that managers use the appropriate stochastic discount factor to value those future dividends.

Suggested Citation

  • Jean-Pierre DANTHINE & John B. DONALDSON, 2007. "Executive Compensation: The View from General Equilibrium," Cahiers de Recherches Economiques du Département d'Econométrie et d'Economie politique (DEEP) 07.10, Université de Lausanne, Faculté des HEC, DEEP.
  • Handle: RePEc:lau:crdeep:07.10
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    Keywords

    incentives; optimal contracting; stochastic discount factor;

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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