Optimal Executive Compensation: Some Equivalence Results

Abstract:     
This paper studies optimal managerial contracts in two different contracting environments. When contracts can be based on earnings, an optimal contract is interpreted as a combination of base salary, golden parachute and bonus. When earnings are not verifiable, two types of optimal contracts are derived: a contract with restricted stock ownership, and a contract with stock options. These three types of optimal contracts are payoff-equivalent in a strong sense: agents' ex ante and ex post payoffs are the same under all three contracts. This suggests that the choice of contractual form is irrelevant in the environment studied in this paper. Comparative static analyses of optimal contracts generate several testable hypotheses.

Number of Pages in PDF File: 39

JEL Classification: D82, G32, J33

working papers series