Dynamic CEO Compensation
63 Pages Posted: 18 Mar 2009 Last revised: 20 Dec 2013
Date Written: September 30, 2011
We study optimal compensation in a fully dynamic framework where the CEO consumes in multiple periods, can undo the contract by privately saving, and can temporarily inflate earnings. We obtain a simple closed-form contract that yields clear predictions for how the level and performance-sensitivity of pay varies over time and across firms. The contract can be implemented by a "Dynamic Incentive Account": the CEO's expected pay is escrowed into an account that comprises cash and the firm's equity. The account features state-dependent rebalancing to ensure its equity proportion is always sufficient to induce effort, and time-dependent vesting to deter short-termism.
Keywords: Contract theory, executive compensation, incentives, principal-agent problem, private saving, manipulation, vesting
JEL Classification: D2, D3, G34, J3
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