Pay-for-(Persistent)-Luck: CEO Bonuses Under Relational and Formal Contracting

48 Pages Posted: 25 May 2014

See all articles by Jed DeVaro

Jed DeVaro

California State University, East Bay

Jin-Hyuk Kim

University of Colorado at Boulder

Nick Vikander

University of Copenhagen

Date Written: April 8, 2014

Abstract

This study investigates the structure of optimal incentives in a stochastic environment and provides evidence for the use of self-enforcing relational contracts. We show theoretically that under relational contracting, firms can credibly promise chief executive officers (CEOs) larger bonuses in good states than in bad, in a way that depends crucially on the state's persistence and the firm's discount factor. Formal contracting instead implies the same bonus in both states. Estimating an empirical model using ExecuComp data, we find that CEO annual bonuses are related to "luck" in a manner consistent with relational contracting.

Keywords: relational contracts, CEO compensation, pay-for-luck

JEL Classification: C73, D86, J41

Suggested Citation

DeVaro, Jed and Kim, Jin-Hyuk and Vikander, Nick, Pay-for-(Persistent)-Luck: CEO Bonuses Under Relational and Formal Contracting (April 8, 2014). Available at SSRN: https://ssrn.com/abstract=2441174 or http://dx.doi.org/10.2139/ssrn.2441174

Jed DeVaro

California State University, East Bay ( email )

25800 Carlos Bee Boulevard
Hayward, CA California 94542
United States
1(510)885-3289 (Phone)

HOME PAGE: http://www2.cbe.csueastbay.edu/fac_page/final/index.php?id=308

Jin-Hyuk Kim

University of Colorado at Boulder ( email )

Campus Box 256
Boulder, CO 80309
United States

Nick Vikander (Contact Author)

University of Copenhagen ( email )

Nørregade 10
Copenhagen, København DK-1165
Denmark

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