Dynamic CEO Compensation

63 Pages Posted: 18 Mar 2009 Last revised: 20 Dec 2013

See all articles by Alex Edmans

Alex Edmans

London Business School - Institute of Finance and Accounting; European Corporate Governance Institute (ECGI); Centre for Economic Policy Research (CEPR)

Xavier Gabaix

Harvard University - Department of Economics; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)

Tomasz Sadzik

New York University (NYU)

Yuliy Sannikov

University of California, Berkeley - Department of Economics; Princeton University - Department of Economics

Multiple version iconThere are 3 versions of this paper

Date Written: September 30, 2011

Abstract

We study optimal compensation in a fully 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 varies over time and across firms. The contract can be implemented by a "Dynamic Incentive Account": the CEO's expected pay is escrowed into an 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.

Keywords: Contract theory, executive compensation, incentives, principal-agent problem, private saving, manipulation, vesting

JEL Classification: D2, D3, G34, J3

Suggested Citation

Edmans, Alex and Gabaix, Xavier and Sadzik, Tomasz and Sannikov, Yuliy, Dynamic CEO Compensation (September 30, 2011). Journal of Finance 67(5), 1603-1647, October 2012, Available at SSRN: https://ssrn.com/abstract=1361797

Alex Edmans (Contact Author)

London Business School - Institute of Finance and Accounting ( email )

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European Corporate Governance Institute (ECGI) ( email )

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Centre for Economic Policy Research (CEPR) ( email )

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Xavier Gabaix

Harvard University - Department of Economics ( email )

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National Bureau of Economic Research (NBER)

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Centre for Economic Policy Research (CEPR)

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United Kingdom

European Corporate Governance Institute (ECGI)

c/o the Royal Academies of Belgium
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1000 Brussels
Belgium

Tomasz Sadzik

New York University (NYU) ( email )

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Yuliy Sannikov

University of California, Berkeley - Department of Economics ( email )

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Berkeley, CA 94720-3880
United States

Princeton University - Department of Economics

Princeton, NJ 08544-1021
United States

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