Finance Papers

Document Type

Journal Article

Date of this Version

2012

Publication Source

The Journal of Finance

Volume

67

Issue

5

Start Page

1603

Last Page

1647

DOI

10.1111/j.1540-6261.2012.01768.x

Abstract

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.

Copyright/Permission Statement

This is the peer reviewed version of the following article, which has been published in final form at http://dx.doi.org/10.1111/j.1540-6261.2012.01768.x. This article may be used for non-commercial purposes in accordance with Wiley Terms and Conditions for Self-Archiving.

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Date Posted: 27 November 2017

This document has been peer reviewed.