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Dynamic CEO CompensationAlex EdmansLondon Business School - Institute of Finance and Accounting; University of Pennsylvania - The Wharton School; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI); Centre for Economic Policy Research (CEPR) Xavier GabaixNew York University - Stern School of Business; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI) Tomasz SadzikNew York University (NYU) Yuliy SannikovUniversity of California, Berkeley - Department of Economics; Princeton University - Department of Economics September 30, 2011 Journal of Finance, Forthcoming Abstract: We study optimal compensation in a fully dynamic framework where the CEO consumes in multiple periods, can undo the contract by privately saving, and can temporarily inflate earnings. We obtain a simple closed-form contract that yields clear predictions for how the level and performance-sensitivity of pay varies over time and across firms. The contract can be implemented by a "Dynamic Incentive Account": the CEO's expected pay is escrowed into an account that comprises cash and the firm's equity. The account features state-dependent rebalancing to ensure its equity proportion is always sufficient to induce effort, and time-dependent vesting to deter short-termism.
Number of Pages in PDF File: 63 Keywords: Contract theory, executive compensation, incentives, principal-agent problem, private saving, manipulation, vesting JEL Classification: D2, D3, G34, J3 Accepted Paper SeriesDate posted: March 18, 2009 ; Last revised: December 7, 2011Suggested CitationContact Information
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