Maintaining Optimal CEO Incentives Through Equity Grants and CEO Portfolio Rebalancing
52 Pages Posted: 31 May 2002
Date Written: August 2002
This paper examines the joint hypotheses that firms set optimal levels for CEO incentives, and that firms and CEOs jointly correct deviations from these optimal levels through equity grants and CEO portfolio rebalancing. I investigate two equity-based CEO incentives, pay-for-performance sensitivity and risk-taking incentive. Pay-for-performance sensitivity is defined as the change in CEO wealth for a given change in the firm's stock price, while risk-taking incentive the sensitivity of CEO wealth to equity risk. I find that firms' and CEOs' combined annual adjustment to pay-for-performance sensitivity or risk-taking incentive is negatively related to the degree that each incentive deviates from its target level at the beginning of the year, consistent with firms and CEOs jointly correcting the incentive deviations. Overall, the findings suggest that firms and CEOs coordinate their equity-granting and portfolio-rebalancing decisions to manage optimal CEO incentive levels consistent with economic theory.
Keywords: Contracting, Managerial Compensation, Managerial Ownership, Equity incentives, Pay-for-performance Sensitivity, Risk-taking Incentive, Equity Grants, CEO Portfolio Rebalancing
JEL Classification: G32, J33, J42, M4
Suggested Citation: Suggested Citation