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Executive Compensation: A General Equilibrium Perspective

Author

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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. General equilibrium considerations thus provide a potential resolution of the "pay for luck" puzzle. We also demonstrate that one sided "relative performance evaluation" follows equally naturally when managers and shareholders are differentially risk averse.

Suggested Citation

  • Jean-Pierre Danthine & John B. Donaldson, 2010. "Executive Compensation: A General Equilibrium Perspective," Working Papers 2010-19, Swiss National Bank.
  • Handle: RePEc:snb:snbwpa:2010-19
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    References listed on IDEAS

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    Cited by:

    1. Oliver Levine & Brent Glover, 2014. "Idiosyncratic Risk and the Manager," 2014 Meeting Papers 736, Society for Economic Dynamics.
    2. Mukherjee, Rahul, 2015. "Institutions, Corporate Governance and Capital Flows," Journal of International Economics, Elsevier, vol. 96(2), pages 338-359.
    3. Pierre Chaigneau, 2012. "On the Value of Improved Informativeness," Cahiers de recherche 1205, CIRPEE.

    More about this item

    Keywords

    incentives; optimal contracting; stochastic discount factor; pay-for-luck; relative performance;

    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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