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Why Do Firms Use Incentives That Have No Incentive Effects?
Author(s) -
Oyer Paul
Publication year - 2004
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/j.1540-6261.2004.00674.x
Subject(s) - stock options , incentive , luck , executive compensation , principal–agent problem , compensation (psychology) , business , agency (philosophy) , stock (firearms) , constraint (computer aided design) , incentive program , microeconomics , actuarial science , finance , economics , corporate governance , mechanical engineering , psychology , philosophy , theology , epistemology , psychoanalysis , engineering
This paper illustrates why firms might choose to implement stock option plans or other pay instruments that reward “luck.” I consider a model where adjusting compensation contracts is costly and where employees' outside opportunities are correlated with their firms' performance. The model may help to explain the use and recent rise of broad‐based stock option plans, as well as other financial instruments, even when these pay plans have no effect on employees' on‐the‐job behavior. The model suggests that agency theory's often‐overlooked participation constraint may be an important determinant of some common compensation schemes, particularly for employees below the highest executive ranks.