Incentive Pay that Causes Inefficient Managerial Replacement
ã€€ã€€ Using contract theory, this article considers the effect of stock-based compensation on managerial replacement. I show that while stock-based compensation solves the moral hazard problem, it creates a distortion in the principal's managerial replacement decisions. Specifically, I show the principal endogenously determines the agent's tenure in a way that maximizes her own expected payoff, where her rational choice to replace or retain the incumbent agent may depart from the total firm value maximization. I find that along the parametric range of control benefit, both long- and short-term vested stock options may exhibit over-replacement of the incumbent agent, but in some cases, long-term vested options may cause more ineÂ¢ ciency than short-term vested options. The article also indicates that only the short-term vested options may exhibit under-replacement. Journal of Economic Literature Classifications:
|Date of creation:||Jun 2013|
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