Executive Compensation and the Optimality of Managerial Entrenchment

Rodney L. White Center for Financial Research Working Paper Series # 15-96

Posted: 7 Oct 1996

See all articles by Gary B. Gorton

Gary B. Gorton

Yale School of Management; National Bureau of Economic Research (NBER); Yale University - Yale Program on Financial Stability

Bruce D. Grundy

University of Melbourne

Multiple version iconThere are 2 versions of this paper

Date Written: September 1996

Abstract

Firms are more complicated than standard principal-agent theory allows: firms have assets-in-place; firms endure through time, allowing for the possibility of replacing a shirking manager; firms have many managers, constraining the amount of equity that can be awarded to any one manager; and, a firm's owner can transfer some control to a manager, thereby entrenching her. Recognizing these characteristics, we solve for the vesting dates; wage, equity and options components; and control rights of an optimal contract. Managerial entrenchment makes the promise of deferred compensation credible. Deferring compensation by delaying vesting reduces a manager's ability to free-ride on a replacement's effort.

JEL Classification: D2, G3, J3

Suggested Citation

Gorton, Gary B. and Grundy, Bruce D., Executive Compensation and the Optimality of Managerial Entrenchment (September 1996 ). Rodney L. White Center for Financial Research Working Paper Series # 15-96, Available at SSRN: https://ssrn.com/abstract=7787

Gary B. Gorton

Yale School of Management ( email )

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HOME PAGE: http://mba.yale.edu/faculty/profiles/gorton.shtml

National Bureau of Economic Research (NBER)

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Yale University - Yale Program on Financial Stability

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P.O. Box 208200
New Haven, CT 06520-8200
United States

Bruce D. Grundy (Contact Author)

University of Melbourne ( email )

Faculty of Economics & Commerce
Department of Finance
Victoria, 3010
Australia
+61 3 8344 9083 (Phone)
+61 3 8344 6914 (Fax)

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