Efficiency in CEO Contracting: A Long-term Perspective

The full CEO contract is a complex combination of a series of contracts and agreements made during the CEO’s complete tenure. This means that the contract in place at a specific point in time is necessarily an incomplete representation of the full CEO contract. The incomplete nature of the CEO contract at a specific time makes it difficult to answer the question whether CEO contracts predominantly manifest optimal contracting or managerial power. We address this question using key terms of the full CEO contract that have been underexplored by prior literature: the length of the CEO’s complete tenure as well as total compensation and payout over the CEO’s complete tenure. These key terms are determined jointly by the CEO and the Board as outcomes of a series of actions and responses, including realized performance over the CEO’s complete tenure. We find that the length of CEO tenure increases with CEO performance. Moreover, we find that the level of total pay and payout percentage increase significantly more with tenure that is related with CEO performance than tenure that is unrelated with CEO performance. Together, these findings indicate that CEO contracts predominantly manifest optimal contracting over managerial power.

(This paper was formerly titled "Implications of Estimation Error in Option Grants for Evaluating CEO Pay" and "On the Quality of CEO Option Pay Estimates")

Keywords: CEO compensation, stock options, outsider CEOs, option exercise, institutional shareholders

JEL Classification: J33, J41, G32

Suggested Citation: Suggested Citation

Anderson, Mark C. and Hyun, Soonchul and Muslu, Volkan and Yu, Dongning, Efficiency in CEO Contracting: A Long-term Perspective (January 1, 2021). AAA 2011 Management Accounting Section (MAS) Meeting Paper, Available at SSRN: https://ssrn.com/abstract=1623467 or http://dx.doi.org/10.2139/ssrn.1623467