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The Optimal Duration of Executive Compensation: Theory and Evidence

43 Pages Posted: 10 Aug 2010 Last revised: 9 Jan 2013

Radhakrishnan Gopalan

Washington University in St. Louis - John M. Olin Business School

Todd T. Milbourn

Washington University in Saint Louis - Olin Business School

Fenghua Song

Pennsylvania State University - Smeal College of Business

Anjan V. Thakor

Washington University, Saint Louis - John M. Olin School of Business; European Corporate Governance Institute (ECGI)

Date Written: August 10, 2010

Abstract

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

Gopalan, Radhakrishnan and Milbourn, Todd T. and Song, Fenghua and Thakor, Anjan V., The Optimal Duration of Executive Compensation: Theory and Evidence (August 10, 2010). AFA 2012 Chicago Meetings Paper. Available at SSRN: https://ssrn.com/abstract=1656603 or http://dx.doi.org/10.2139/ssrn.1656603

Radhakrishnan Gopalan

Washington University in St. Louis - John M. Olin Business School ( email )

One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States

Todd T. Milbourn

Washington University in Saint Louis - Olin Business School ( email )

1 Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States
314-935-6392 (Phone)
314-935-6359 (Fax)

HOME PAGE: http://www.olin.wustl.edu/faculty/milbourn/

Fenghua Song (Contact Author)

Pennsylvania State University - Smeal College of Business ( email )

University Park, PA 16802
United States
814.863.4905 (Phone)
814.865.3362 (Fax)

HOME PAGE: http://www.personal.psu.edu/fxs16

Anjan V. Thakor

Washington University, Saint Louis - John M. Olin School of Business ( email )

One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States

European Corporate Governance Institute (ECGI) ( email )

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

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