Regulating Deferred Incentive Pay

Abstract

Our paper evaluates recent regulatory proposals mandating the deferral of bonus payments and claw-back clauses in the financial sector. We study a broadly applicable principal agent setting, in which the agent exerts effort for an immediately observable task (acquisition) and a task for which information is only gradually available over time (diligence). Optimal compensation contracts trade off the cost and benefit of delay resulting from agent impatience and the informational gain. Mandatory deferral may increase or decrease equilibrium diligence depending on the importance of the acquisition task. In particular, higher acquisition incentives make it more likely that deferral regulation increases equilibrium diligence. Our results imply concrete conditions on economic primitives that make mandatory deferral socially (un)desirable.

Principles versus principal: Reconciling norm compliance and shareholder value

“…This task belongs to the firm's board of directors. In fulfillment of its fiduciary duty of loyalty towards the firm (Lan & Heracleous, ), the board will usually align CEO pay according to shareholders/Principal A's interests, but (through clawback provisions, say; see Babenko et al, 2017; Hoffman et al, , and many others) it might also make this pay contingent on the penalties and rewards which a regulator can impose.…”

Stock vesting conditions, control benefits and managerial replacement

“…This paper differs from Inderst and Mueller (2010) because it develops a model that examines inefficient CEO replacement/retention from the perspective of longand short-term vested options. Hoffmann et al (2014) present a characterization of optimal compensation under a multi-task setting in which a bank employee privately chooses (customer) acquisition effort and diligence. By imposing a minimum deferral period, they show that mandatory deferral of incentive pay may lead to lower rather than higher diligence if the acquisition effort cost is relatively low, that is, if it is less difficult to attract new customers and deal opportunities.…”

“…In relation to recent controversy about mandatory deferral of incentive pay in the EU following the Global Financial Crisis (see Hoffmann et al 2014) about the extension of the clawback period in the regulation of the clawback rule, this study provides some useful insight into cases in which both mandatory deferral and clawback policies do not necessarily solve existing inefficiencies related to CEO turnover, but may even aggravate them. For example, if the performance of the incumbent manager is bad, the mandatory deferral policy may eliminate under-replacement but may aggravate over-replacement in less established or small firms.…”

Regulating commissions in markets with advice

“…Hoffman et al (2013) consider the contracting problem between a firm and an agent when the agent has both to exert effort to acquire a customer and to exert diligence to ensure that ultimately no "bad outcome" is realized in the future. While their model is tailored more to regulation in banking, where the "bad outcome" generates a (potentially "systemic") externality on third parties, the results can be applied more widely, notably also to the case where such an externality is imposed on the customer (e.g., through personal bankruptcy).…”