The Complexity of CEO Compensation

46 Pages Posted: 6 Sep 2014

See all articles by Arantxa Jarque

Arantxa Jarque

Federal Reserve Banks - Federal Reserve Bank of Richmond

Date Written: September 3, 2014

Abstract

I study firm characteristics that justify the use of options or refresher grants in the optimal compensation packages for CEOs in the presence of moral hazard. I model explicitly the determination of stock prices as a function of the output realizations of the firm: Symmetric learning by all parties about the exogenous quality of the firm makes stock prices sensitive to output observations. Compensation packages are designed to transform this sensitivity of prices-to-output into the sensitivity of consumption-to-output that is dictated by the optimal contract. Heterogeneity in the structure of firm uncertainty implies that some firms are able to implement the optimal contract with very simple schemes that do not include options, refresher grants, or perks, while others need to use these more complex and potentially less transparent instruments.

Keywords: mechanism design, moral hazard, CEO compensation, stock options, repricing

JEL Classification: D80, D82, D86, G30

Suggested Citation

Jarque, Arantxa, The Complexity of CEO Compensation (September 3, 2014). FRB Richmond Working Paper No. 14-16, Available at SSRN: https://ssrn.com/abstract=2492181 or http://dx.doi.org/10.2139/ssrn.2492181

Arantxa Jarque (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Richmond ( email )

P.O. Box 27622
Richmond, VA 23261
United States

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