Executive Compensation, Incentives, and Risk

Abstract

Executive Compensation, Incentives, and Risk 1 This paper analyzes the link between equity-based compensation and created incentives by (1) deriving a measure of incentives suitable for both linear and non-linear compensation contracts, (2) analyzing the effect of risk on incentives, and (3) clarifying the role of the agent's private trading decisions in incentive creation. With option-based compensation contracts, the average pay-forperformance sensitivity is not an adequate measure of ex-ante incentives. Pay-for-performance covaries negatively with marginal utility and hence overstates the created incentives. Second, more noise in the performance measure implies that the manager is less certain about the effect of effort on performance, which in turn makes her less willing to exert effort. Finally, the private trading decisions by the manager have first-order effects on incentives. By reducing her holdings of the market asset, the manager achieves an effect similar to "indexing" the stock or option grant, making explicit indexation of the contract redundant.

Executive Compensation: A Survey of Theory and Evidence

“…Garvey and Milbourn (2006) provide more evidence that positive shocks to industry performance a¤ect CEO pay more strongly than negative ones. On the other hand, CEOs are more likely to be …red after bad industry or bad market performance, which indicates that some CEOs are penalized for bad luck (Jenter and Kanaan, 2015).…”

“…Using a rank-based speci…cation, they …nd signi…cant evidence of RPE. 36 Hence, a mixed picture emerges: RPE is explicitly used in many executive contracts, and 35 CEO …ring decisions also appear to be a¤ected by industry and market performance (Jenter and Kanaan, 2015). 36 In addition, De Angelis and Grinstein (2017) examine the motives for RPE.…”

Lower Salaries and No Options? On the Optimal Structure of Executive Pay

“…3 Hence, we feel entitled to argue that our modeling approach implements a variant of the "conventional" model. 2 CRRA preferences and lognormal prices have been used by Lambert, Larcker, and Verrecchia (1991), Hall and Murphy (2000), (2002), Himmelberg and Hubbard (2000), Hall and Knox (2004), Jenter (2002) and Oyer and Schaefer (2003). Closely related are models that combine CRRA-preferences with geometric binomial trees or geometric Brownian motion models of stock price development that generate identical or similar distributions of stock prices.…”

Monitoring, Contractual Incentive Pay, and the Structure of CEO Equity-Based Compensation

“…However, options tend to pay off in states in which CEO's marginal utility is already low, which means that the actual incentives created for a given sensitivity are much smaller for options than for stock ((Jenter (2002 ))).…”