Stock Grants as a Commitment Device

Posted: 10 Mar 2007

See all articles by Gian Luca Clementi

Gian Luca Clementi

New York University - Leonard N. Stern School of Business; National Bureau of Economic Research (NBER); University of Bologna - Rimini Center for Economic Analysis (RCEA)

Thomas F. Cooley

New York University - Leonard N. Stern School of Business; National Bureau of Economic Research (NBER)

Cheng Wang

University of Iowa

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Abstract

A large and increasing fraction of the value of executives' compensation is accounted for by security grants. It is often argued that the optimal compensation contracts characterized in the theoretical literature can be implemented by means of stock or option grants. However, in most cases the optimal allocation can be implemented simply by a contingent sequence of cash payments. Security awards are redundant. In this paper we develop a dynamic model of managerial compensation where neither the firm nor the manager can commit to long-term contracts. We show that, in this environment, if stock grants are not used, then the optimal contract collapses to a series of short term contracts. When stock grants are used, however, nonlinear intertemporal schemes can be implemented to achieve better risk-sharing and larger firm value.

JEL Classification: D21, D82, G32

Suggested Citation

Clementi, Gian Luca and Cooley, Thomas F. and Wang, Cheng, Stock Grants as a Commitment Device. Journal of Economic Dynamics and Control, Vol. 30, No. 11, pp. 2191-2216, 2006. Available at SSRN: https://ssrn.com/abstract=968758 or http://dx.doi.org/10.2139/ssrn.329629

Gian Luca Clementi (Contact Author)

New York University - Leonard N. Stern School of Business ( email )

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Thomas F. Cooley

New York University - Leonard N. Stern School of Business ( email )

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Cheng Wang

University of Iowa ( email )

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