CEO Compensation and Strategy Inertia

37 Pages Posted: 25 May 2006

See all articles by Roman Inderst

Roman Inderst

Goethe University Frankfurt

Holger M. Mueller

New York University (NYU) - Department of Finance; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)

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Date Written: May 2006

Abstract

This paper considers the joint optimal design of CEOs' on-the-job compensation and severance pay in a general optimal contracting framework. We obtain a novel argument for high-powered, non-linear CEO compensation such as bonus schemes and option grants that is different from existing arguments based on moral hazard and risk taking. Based on this argument, the CEO's optimal on-the-job compensation scheme is designed to minimize the use of costly severance pay to reduce CEO entrenchment, thus minimizing the CEO's informational rents. Our model generates novel empirical predictions concerning the interrelation of CEOs' on-the-job compensation and severance pay as well as CEO turnover which, to the extent that they have been tested, are consistent with the empirical evidence.

Suggested Citation

Inderst, Roman and Mueller, Holger M., CEO Compensation and Strategy Inertia (May 2006). Available at SSRN: https://ssrn.com/abstract=904200 or http://dx.doi.org/10.2139/ssrn.904200

Roman Inderst

Goethe University Frankfurt ( email )

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HOME PAGE: http://www.wiwi.uni-frankfurt.de/en/departments/finance/lehrstuhl/prof-dr-roman-inderst/team

Holger M. Mueller (Contact Author)

New York University (NYU) - Department of Finance ( email )

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HOME PAGE: http://www.stern.nyu.edu/~hmueller/

National Bureau of Economic Research (NBER) ( email )

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Centre for Economic Policy Research (CEPR)

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European Corporate Governance Institute (ECGI) ( email )

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Belgium

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