The Optimal Duration of Executive Compensation: Theory and Evidence

43 Pages Posted: 10 Aug 2010 Last revised: 9 Jan 2013

See all articles by Radhakrishnan Gopalan

Radhakrishnan Gopalan

Washington University in St. Louis - John M. Olin Business School

Todd T. Milbourn

Washington University in Saint Louis - Olin Business School

Fenghua Song

Pennsylvania State University - Smeal College of Business

Anjan V. Thakor

Washington University in St. Louis - John M. Olin Business School; Financial Theory Group; European Corporate Governance Institute (ECGI); Massachusetts Institute of Technology (MIT) - Laboratory for Financial Engineering

Date Written: August 10, 2010

Abstract

While much is made of the ills of “short-termism” in executive compensation, in reality very little is known empirically about the extent of short-termism in CEO compensation. This paper develops a new measure of CEO pay duration that reflects the vesting periods of different components of compensation, thereby quantifying the extent to which compensation is short-term and the extent to which it is long-term. It also develops a theoretical model that generates three predictions for which we find strong empirical support using our measure of pay duration. First, optimal pay duration is decreasing in the extent of mispricing of the firm’s stock. Second, optimal pay duration is longer in firms with poorer corporate governance. Third, CEOs with shorter pay durations are more likely to engage in myopic investment behavior, and this relationship is stronger when the extent of stock mispricing is larger.

Keywords: Executive Compensation, Vesting, Duration, Managerial Myopia, Corporate Governance

JEL Classification: G30, J33

Suggested Citation

Gopalan, Radhakrishnan and Milbourn, Todd T. and Song, Fenghua and Thakor, Anjan V., The Optimal Duration of Executive Compensation: Theory and Evidence (August 10, 2010). AFA 2012 Chicago Meetings Paper, Available at SSRN: https://ssrn.com/abstract=1656603 or http://dx.doi.org/10.2139/ssrn.1656603

Radhakrishnan Gopalan

Washington University in St. Louis - John M. Olin Business School ( email )

One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States

Todd T. Milbourn

Washington University in Saint Louis - Olin Business School ( email )

1 Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States
314-935-6392 (Phone)
314-935-6359 (Fax)

HOME PAGE: http://www.olin.wustl.edu/faculty/milbourn/

Fenghua Song (Contact Author)

Pennsylvania State University - Smeal College of Business ( email )

University Park, PA 16802
United States
814.863.4905 (Phone)

HOME PAGE: http://sites.google.com/site/fenghua8song/

Anjan V. Thakor

Washington University in St. Louis - John M. Olin Business School ( email )

One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States

Financial Theory Group ( email )

United States

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

Massachusetts Institute of Technology (MIT) - Laboratory for Financial Engineering ( email )

100 Main Street, E62-618
Cambridge, MA 02142
United States

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