Stock Option Vesting Conditions, CEO Turnover, and Myopic Investment

Abstract

Corporations have been criticized for providing executives with excessive incentives to focus on short-term performance. This paper shows that investment in short-term projects has beneficial effects in that it provides early feedback about CEO talent, which leads to more efficient CEO replacement decisions. Due to the threat of CEO turnover, the optimal design of stock option vesting conditions in executive compensation is more subtle than conventional views suggest. For example, I show that long vesting periods can backfire and induce excessive short-term investments. The study generates new empirical predictions regarding the determinants and impacts of stock option vesting terms in optimal contracting.

Keywords: Executive Compensation, Stock Option Vesting Conditions, Myopic Investment, CEO Turnover