Manipulation and Equity-Based Compensation

13 Pages Posted: 24 Apr 2011

See all articles by Lin Peng

Lin Peng

City University of New York, Baruch College - Zicklin School of Business - Department of Economics and Finance

Ailsa Röell

Columbia University, School of International and Public Affairs

Date Written: January 18, 2008

Abstract

This paper models optimal executive compensation in a setting where managers are in a position to influence the public perception of their company, and thus the short-term stock price. Stock prices take the possibility of manipulation into account but fail to fully back it out, the degree of manipulation, due to investors’ uncertainty about managers’ ability to manipulate effectively. An novel property of our specification is that it is the elasticity of managers' wealth to firm value, not the sensitivity, that determines effort. We show that manipulation costs result in an optimal contract that has a lower equilibrium choice of effort, even though the elasticity of pay with respect to the stock price may be higher if there is uncertainty about the degree of manipulation. We conclude by discussing possible extensions to the model and policy implications.

Keywords: Manipulation, executive compensation, pay elasticity

Suggested Citation

Peng, Lin and Röell, Ailsa A., Manipulation and Equity-Based Compensation (January 18, 2008). American Economic Review, Vol. 98, No. 2, pp. 285-90, 2008, Available at SSRN: https://ssrn.com/abstract=1820095

Lin Peng (Contact Author)

City University of New York, Baruch College - Zicklin School of Business - Department of Economics and Finance ( email )

17 Lexington Avenue
New York, NY 10010
United States

Ailsa A. Röell

Columbia University, School of International and Public Affairs ( email )

3022 Broadway
New York, NY 10027
United States
(212) 854-9289 (Phone)

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