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Dynamic CEO Compensation
Author(s) -
EDMANS ALEX,
GABAIX XAVIER,
SADZIK TOMASZ,
SANNIKOV YULIY
Publication year - 2012
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.1540-6261.2012.01768.x
Subject(s) - vesting , undo , equity (law) , incentive , executive compensation , earnings , cash , cash flow , compensation (psychology) , business , microeconomics , economics , finance , computer science , art , psychology , political science , psychoanalysis , law , visual arts , operating system
We study optimal compensation in a dynamic framework where the CEO consumes in multiple periods, can undo the contract by privately saving, and can temporarily inflate earnings. We obtain a simple closed‐form contract that yields clear predictions for how the level and performance sensitivity of pay vary over time and across firms. The contract can be implemented by escrowing the CEO's pay into a “Dynamic Incentive Account” that comprises cash and the firm's equity. The account features state‐dependent rebalancing to ensure its equity proportion is always sufficient to induce effort, and time‐dependent vesting to deter short‐termism.