CEO Horizon, Optimal Pay Duration, and the Escalation of Short-Termism

86 Pages Posted: 10 Jan 2019

See all articles by Ivan Marinovic

Ivan Marinovic

Graduate School of Business, Stanford University

Felipe Varas

Duke University - Fuqua School of Business - Finance Department

Date Written: April 13, 2018

Abstract

This paper studies optimal CEO contracts when managers manipulate their performance measure, sometimes at the expense of firm value. Optimal contracts defer compensation. The manager’s incentives vest over time at an increasing rate, and compensation becomes increasingly sensitive to short-term performance. This process generates an endogenous CEO horizon problem whereby managers intensify performance manipulation in their final years in office. Contracts are designed to foster effort while minimizing the adverse effects of manipulation. We characterize the optimal mix of short- and long-term compensation along the manager’s tenure, the optimal vesting period of incentive pay, and the resulting dynamics of managerial short-termism over the CEO’s tenure. Our paper provides a rationale for issuing stock awards with performance-based vesting provisions, a practice increasingly adopted by U.S. firms.

Keywords: dynamic moral hazard, earnings management, CEO horizon, equity vesting, deferred compensation

JEL Classification: D82, D83

Suggested Citation

Marinovic, Ivan and Varas, Felipe, CEO Horizon, Optimal Pay Duration, and the Escalation of Short-Termism (April 13, 2018). Available at SSRN: https://ssrn.com/abstract=3308188 or http://dx.doi.org/10.2139/ssrn.3308188

Ivan Marinovic (Contact Author)

Graduate School of Business, Stanford University ( email )

655 Knight Way
Stanford, CA 94305-5015
United States

Felipe Varas

Duke University - Fuqua School of Business - Finance Department ( email )

Durham, NC 27708-0120
United States

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