Executive Compensation and Stock Options: An Inconvenient Truth
32 Pages Posted: 8 Jul 2008
Date Written: June 14, 2008
We reexamine the issue of executive compensation within a general equilibrium production context. Intertemporal optimality places strong restrictions on the form of a representative manager's compensation contract, restrictions that appear to be incompatible with the fact that the bulk of many high-proffile managers' compensation is in the form of various options and option-like rewards. We therefore measure the extent to which a convex contract alone can induce the manager to adopt near-optimal investment and hiring decisions. To ask this question is essentially to ask if such contracts can effectively align the stochastic discount factor of the manager with that of the shareholder-workers. We detail exact circumstances under which this alignment is possible and when it is not.
Keywords: corporate governance, optimal contracting, business cycles
JEL Classification: E32, E44
Suggested Citation: Suggested Citation