Executive Compensation and Stock Options: An Inconvenient Truth

31 Pages Posted: 20 Aug 2008

See all articles by Jean-Pierre Danthine

Jean-Pierre Danthine

University of Lausanne - Institute of Banking and Finance (IBF); Centre for Economic Policy Research (CEPR); Swiss Finance Institute

John B. Donaldson

Columbia Business School - Finance and Economics

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Date Written: June 2008

Abstract

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-profile 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: business cycles, convex contracts, corporate governance, executive compensation, optimal contracting, stock options

JEL Classification: E32, E44

Suggested Citation

Danthine, Jean-Pierre and Donaldson, John B., Executive Compensation and Stock Options: An Inconvenient Truth (June 2008). CEPR Discussion Paper No. DP6890, Available at SSRN: https://ssrn.com/abstract=1240200

Jean-Pierre Danthine (Contact Author)

University of Lausanne - Institute of Banking and Finance (IBF) ( email )

Lausanne, 1015
Switzerland
+41 21 692 3485 (Phone)
+41 21 692 3335 (Fax)

HOME PAGE: http://www.hec.unil.ch/jdanthine/

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Swiss Finance Institute ( email )

c/o University of Geneve
40, Bd du Pont-d'Arve
1211 Geneva, CH-6900
Switzerland

John B. Donaldson

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
United States

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