The Optimal Duration of Executive Compensation: Theory and Evidence
43 Pages Posted: 10 Aug 2010 Last revised: 9 Jan 2013
Date Written: August 10, 2010
While much is made of the ills of “short-termism” in executive compensation, in reality very little is known empirically about the extent of short-termism in CEO compensation. This paper develops a new measure of CEO pay duration that reflects the vesting periods of different components of compensation, thereby quantifying the extent to which compensation is short-term and the extent to which it is long-term. It also develops a theoretical model that generates three predictions for which we find strong empirical support using our measure of pay duration. First, optimal pay duration is decreasing in the extent of mispricing of the firm’s stock. Second, optimal pay duration is longer in firms with poorer corporate governance. Third, CEOs with shorter pay durations are more likely to engage in myopic investment behavior, and this relationship is stronger when the extent of stock mispricing is larger.
Keywords: Executive Compensation, Vesting, Duration, Managerial Myopia, Corporate Governance
JEL Classification: G30, J33
Suggested Citation: Suggested Citation