Labor Market Immobility and Incentive Contract Design

50 Pages Posted: 30 Nov 2018 Last revised: 17 Feb 2019

See all articles by Chen Lin

Chen Lin

The University of Hong Kong - Faculty of Business and Economics

Lai Wei

Lingnan University - Department of Finance and Insurance

Nan Yang

Hong Kong Polytechnic University - School of Accounting and Finance

Date Written: November 20, 2018

Abstract

This paper studies the effects of heightened labor market immobility on top managers’ incentive contract design. Heightened immobility prohibits managers from threatening to leave ex post, limiting their ability to hold up firms after firms invest in their human capital. By reducing the holdup issue and enhancing the bargaining power, increased immobility enhances firms’ incentive to invest and make it less costly for firms to adjust managerial incentive schemes. Using the staggered adoption of the Inevitable Disclosure Doctrine across U.S. states as an exogenous negative shock to skilled labor mobility, we find that the law causes a firm to increase the convexity of option holdings of its top managers and to lengthen the vesting schedules of their new option grants. We find little change of pay-for-performance sensitivity. Finally, we find that the law makes option repricing become more sensitive to poor performance beyond managers’ control. Hence, our results are consistent with a prominent yet little tested theory in finance on the optimal incentive schemes that motivate managers’ innovation effort.

Keywords: labor market mobility, executive compensation, risk-taking incentive, incentive horizon, option repricing

JEL Classification: G30

Suggested Citation

Lin, Chen and Wei, Lai and Yang, Nan, Labor Market Immobility and Incentive Contract Design (November 20, 2018). Available at SSRN: https://ssrn.com/abstract=3289225 or http://dx.doi.org/10.2139/ssrn.3289225

Chen Lin

The University of Hong Kong - Faculty of Business and Economics ( email )

Pokfulam Road
Hong Kong
China

Lai Wei (Contact Author)

Lingnan University - Department of Finance and Insurance ( email )

8 Castle Peak Road
Lingnan University
Hong Kong, New Territories
China

Nan Yang

Hong Kong Polytechnic University - School of Accounting and Finance ( email )

Hung Hom
Kowloon
Hong Kong

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