Maintaining Optimal CEO Incentives Through Equity Grants and CEO Portfolio Rebalancing

52 Pages Posted: 31 May 2002

See all articles by Ying Li Compton

Ying Li Compton

Securities and Exchange Commission; George Washington University - School of Business

Date Written: August 2002

Abstract

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

Compton, Ying Li, Maintaining Optimal CEO Incentives Through Equity Grants and CEO Portfolio Rebalancing (August 2002). MIT Sloan Working Paper No. 4371-02. Available at SSRN: https://ssrn.com/abstract=314646 or http://dx.doi.org/10.2139/ssrn.314646

Ying Li Compton (Contact Author)

Securities and Exchange Commission ( email )

450 Fifth Street, NW
Washington, DC 20549-1105
United States

George Washington University - School of Business ( email )

2201 G Street NW
Funger 610
Washington, DC 20052
United States
(202)994-1268 (Phone)

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