Dynamic CEO Compensation

63 Pages Posted: 18 Mar 2009 Last revised: 20 Dec 2013

Alex Edmans

London Business School - Institute of Finance and Accounting; European Corporate Governance Institute (ECGI); Centre for Economic Policy Research (CEPR)

Xavier Gabaix

Harvard University - Department of Economics; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI); New York University - Stern School of Business

Tomasz Sadzik

New York University (NYU)

Yuliy Sannikov

University of California, Berkeley - Department of Economics; Princeton University - Department of Economics

Multiple version iconThere are 3 versions of this paper

Date Written: September 30, 2011

Abstract

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

Suggested Citation

Edmans, Alex and Gabaix, Xavier and Sadzik, Tomasz and Sannikov, Yuliy, Dynamic CEO Compensation (September 30, 2011). Journal of Finance 67(5), 1603-1647, October 2012. Available at SSRN: https://ssrn.com/abstract=1361797

Alex Edmans (Contact Author)

London Business School - Institute of Finance and Accounting ( email )

Sussex Place
Regent's Park
London NW1 4SA
United Kingdom

European Corporate Governance Institute (ECGI) ( email )

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

Centre for Economic Policy Research (CEPR) ( email )

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

Xavier Gabaix

New York University - Stern School of Business ( email )

Stern School of Business
44 West 4th Street, Suite 9-190
New York, NY 10012-1126
United States

HOME PAGE: http://pages.stern.nyu.edu/~xgabaix/

Harvard University - Department of Economics ( email )

Littauer Center
Cambridge, MA 02138
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

Tomasz Sadzik

New York University (NYU) ( email )

Bobst Library, E-resource Acquisitions
20 Cooper Square 3rd Floor
New York, NY 10003-711
United States

Yuliy Sannikov

University of California, Berkeley - Department of Economics ( email )

549 Evans Hall #3880
Berkeley, CA 94720-3880
United States

Princeton University - Department of Economics

Princeton, NJ 08544-1021
United States

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