Own-Company Stockholding and Work Effort Preferences of an Unconstrained Executive
37 Pages Posted: 21 Jan 2009 Last revised: 26 Apr 2010
Date Written: January 21, 2009
We develop a framework for analyzing an executive's own-company stockholding and work effort preferences. The executive, characterized by risk aversion and work effectiveness parameters, invests his personal wealth without constraint in the financial market, including the stock of his own company whose value he can directly influence with work effort. The executive's utility-maximizing personal investment and work effort strategy is derived in closed form, and a utility indifference rationale is applied to determine his required compensation. Being unconstrained by performance contracting, the executive's work effort strategy establishes a base case for theoretical or empirical assessment of the benefits or otherwise of constraining executives with performance contracting.
Keywords: optimal portfolio choice, executive compensation
JEL Classification: M52, G11
Suggested Citation: Suggested Citation