Lower salaries and no options? On the optimal structure of executive pay

Lower salaries and no options? On the optimal structure of executive pay

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Article ID: iaor20091188
Country: United Kingdom
Volume: 62
Issue: 1
Start Page Number: 303
End Page Number: 343
Publication Date: Feb 2007
Journal: Journal of Finance
Authors: ,
Keywords: financial, economics
Abstract:

We calibrate the standard principal–agent model with constant relative risk aversion and lognormal stock prices to a sample of 598 U.S. CEOs. We show that this model predicts that most CEOs should not hold any stock options. Instead, CEOs should have lower base salaries and receive additional shares in their companies; many would be required to purchase additional stock in their companies. These contracts would reduce average compensation costs by 20% while providing the same incentives and the same utility to CEOs. We conclude that the standard principal–agent model typically used in the literature cannot rationalize observed contracts.

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