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CEO Contract Design: How Do Strong Principals Do It?

44 Pages Posted: 15 Mar 2011 Last revised: 18 Dec 2012

Henrik Cronqvist

University of Miami - Department of Finance

Rüdiger Fahlenbrach

Ecole Polytechnique Fédérale de Lausanne; Ecole Polytechnique Fédérale de Lausanne - Ecole Polytechnique Fédérale de Lausanne

Date Written: December 12, 2012

Abstract

We study changes in chief executive officer (CEO) contracts when firms transition from public ownership with dispersed owners to private ownership with strong principals in the form of private equity sponsors. The most significant changes are that a significant portion of equity grants performance-vests based on prespecified measures and that unvested equity is forfeited by fired CEOs. Private equity sponsors do not reduce base salaries, bonuses, and perks, but redesign contracts away from qualitative measures. They use some subjective performance evaluation, do not use indexed or premium options, and do not condition vesting on relative industry performance. We compare the contracts to predictions from contracting theories, and relate our results to discussions of executive compensation reform.

Keywords: LBOs, employment contracts, contracting theory, executive compensation

JEL Classification: G30, G34, J33

Suggested Citation

Cronqvist, Henrik and Fahlenbrach, Rüdiger, CEO Contract Design: How Do Strong Principals Do It? (December 12, 2012). Journal of Financial Economics (JFE), Forthcoming; Swiss Finance Institute Research Paper No. 11-14. Available at SSRN: https://ssrn.com/abstract=1786132 or http://dx.doi.org/10.2139/ssrn.1786132

Henrik Cronqvist (Contact Author)

University of Miami - Department of Finance ( email )

P.O. Box 248094
Coral Gables, FL 33124-6552
United States
(305) 515-5898 (Phone)

HOME PAGE: http://sites.google.com/site/henrikcronqvist/

Rüdiger Fahlenbrach

Ecole Polytechnique Fédérale de Lausanne ( email )

Quartier UNIL-Dorigny
Extranef 211
1015 Lausanne, CH-1015
Switzerland
++41-21-693-0098 (Phone)
++41-21-693-3010 (Fax)

HOME PAGE: http://sfi.epfl.ch/fahlenbrach.html

Ecole Polytechnique Fédérale de Lausanne - Ecole Polytechnique Fédérale de Lausanne ( email )

c/o University of Geneve
40, Bd du Pont-d'Arve
1211 Geneva, CH-6900
Switzerland

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