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Stock-Based Compensation and CEO (Dis)Incentives

  • Efraim Benmelech
  • Eugene Kandel
  • Pietro Veronesi

Stock-based compensation is the standard solution to agency problems between shareholders and managers. In a dynamic rational expectations equilibrium model with asymmetric information we show that although stock-based compensation causes managers to work harder, it also induces them to hide any worsening of the firm's investment opportunities by following largely sub-optimal investment policies. This problem is especially severe for growth firms, whose stock prices then become over-valued while managers hide the bad news to shareholders. We find that a firm-specific compensation package based on both stock and earnings performance instead induces a combination of high effort, truth revelation and optimal investments. The model produces numerous predictions that are consistent with the empirical evidence.

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File URL: http://www.nber.org/papers/w13732.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 13732.

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Date of creation: Jan 2008
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Publication status: published as Efraim Benmelech & Eugene Kandel & Pietro Veronesi, 2010. "Stock-Based Compensation and CEO (Dis)Incentives," The Quarterly Journal of Economics, MIT Press, vol. 125(4), pages 1769-1820, November.
Handle: RePEc:nbr:nberwo:13732
Note: CF LS
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