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Sticks or Carrots? Optimal CEO Compensation when Managers Are Loss Averse
Author(s) -
DITTMANN INGOLF,
MAUG ERNST,
SPALT OLIVER
Publication year - 2010
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.1540-6261.2010.01609.x
Subject(s) - stylized fact , loss aversion , compensation (psychology) , microeconomics , economics , executive compensation , regular polygon , principal (computer security) , econometrics , risk aversion (psychology) , expected utility hypothesis , computer science , financial economics , mathematics , incentive , psychology , geometry , psychoanalysis , macroeconomics , operating system
This paper analyzes optimal executive compensation contracts when managers are loss averse. We calibrate a stylized principal‐agent model to the observed contracts of 595 CEOs and show that this model can explain observed option holdings and high base salaries remarkably well for a range of parameterizations. We also derive and calibrate the general shape of the optimal contract that is increasing and convex for medium and high outcomes and that drops discontinuously to the lowest possible payout for low outcomes. Finally, we identify the critical features of the loss‐aversion model that render optimal contracts convex.