Explaining Downward-Rigid CEO Compensation: An Information Asymmetry Perspective

Abstract

CEO compensation rarely gets cut, and almost every component of it increased in early 2000. I consider a two-period contracting problem in which a board privately knows its CEO's matching quality with the firm that changes over time. The board faces a trade-off: Revealing good information makes the CEO work harder, but it is costly. To save the information revelation cost, the board commits to a back-loaded compensation plan that features only upward adjustments in fixed and performance-based pay. This paper also considers extensions in which CEOs have transferable skills and sheds light on bonus caps and compensation disclosure policies.

Keywords: CEO compensation, informed principal, signaling, matching quality, bonus cap, compensation disclosure

JEL Classification: G38, J24, J31, M12