Liquidity and Manipulation of Executive Compensation Schemes

33 Pages Posted: 28 Sep 2009 Last revised: 11 Sep 2012

See all articles by Ulf Axelson

Ulf Axelson

London School of Economics; Swedish Institute for Financial Research (SIFR)

Sandeep Baliga

Northwestern University - Kellogg School of Management

Multiple version iconThere are 2 versions of this paper

Date Written: October 1, 2009

Abstract

Compensation contracts have been criticized for encouraging managers to manipulate information. This includes bonus schemes that encourage earnings smoothing, and option packages that allow managers to cash out early when the firm is overvalued. We show that the intransparency induced by these contract features is critical for giving long-term incentives. Lack of transparency makes it harder for the owner to engage in ex post optimal but ex ante inefficient liquidity provision to the manager. For the same reason, it is often optimal to “pay for luck” (i.e., tie long-term compensation to variables that the manager has no influence over, but may have private information about, such as future profitability of the whole industry).

Keywords: G34, J33

Suggested Citation

Axelson, Ulf and Baliga, Sandeep, Liquidity and Manipulation of Executive Compensation Schemes (October 1, 2009). The Review of Financial Studies, Vol. 22, Issue 10, pp. 3907-3939, 2009. Available at SSRN: https://ssrn.com/abstract=1478811 or http://dx.doi.org/hhn095

Ulf Axelson (Contact Author)

London School of Economics ( email )

United Kingdom

Swedish Institute for Financial Research (SIFR) ( email )

Drottninggatan 89
SE-113 59 Stockholm, SE-113 60
Sweden

Sandeep Baliga

Northwestern University - Kellogg School of Management ( email )

2001 Sheridan Road
Evanston, IL 60208
United States
847-467-4613 (Phone)
847-467-1220 (Fax)

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