Compensation for Managers with Career Concerns: The Role of Stock Option in Optimal Contracts

38 Pages Posted: 9 Feb 2002

See all articles by Tom Nohel

Tom Nohel

Loyola University of Chicago

Steven K. Todd

Loyola University of Chicago

Date Written: January 29, 2002

Abstract

We study the problem of compensating a manager whose career concerns affect his investment strategy. We consider contracts that include cash, shares, and call options, focusing on the role of options in aligning incentives. We find that managers are optimally paid in cash, supplemented by a small amount of call options; shares are excluded. The options are struck at-the-money, consistent with the near uniform practice of compensation committees. The convexity of option payoffs helps to overcome managerial conservatism, though a non-trivial under-investment problem persists. Our model yields several testable implications regarding cross-sectional variation in the size of option grants and pay-for-performance sensitivity.

JEL Classification: G31, G34, J33, L22

Suggested Citation

Nohel, Tom and Todd, Steven K., Compensation for Managers with Career Concerns: The Role of Stock Option in Optimal Contracts (January 29, 2002). Available at SSRN: https://ssrn.com/abstract=299991 or http://dx.doi.org/10.2139/ssrn.299991

Tom Nohel (Contact Author)

Loyola University of Chicago ( email )

820 North Michigan Avenue
Chicago, IL 60611
United States
312-915-7065 (Phone)
312-915-8508 (Fax)

Steven K. Todd

Loyola University of Chicago ( email )

820 North Michigan Avenue
Chicago, IL 60611
United States
(312) 915-7218 (Phone)
(312) 915-8508 (Fax)

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