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Share Repurchases and Pay-Performance Sensitivity of Employee Compensation Contracts



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    • Ilona Babenko is at the Department of Finance, Hong Kong University of Science and Technology. This paper has benefited from insightful comments by Shane Corwin, Chris Hennessy, Nicole Johnson, Kathleen Kahle, Jeffrey LaFrance, Alexandre Mas, John Morgan, Jacob Sagi, Yuliy Sannikov, Mark Seasholes, Andrei Simonov, Yisong Tian, and Nancy Wallace. I am especially grateful to Hayne Leland (my advisor) for his advice. I also thank Campbell R. Harvey (the editor), an associate editor, and an anonymous referee for suggestions that greatly improved the paper. Sandra Rodgers provided excellent research assistance. The Institute of Business and Economic Research support is gratefully acknowledged.


I show that share repurchases increase pay-performance sensitivity of employee compensation and lead to greater employee effort and higher stock prices. Consistent with the model, I find that after repurchases, employees and managers receive fewer stock option and equity grants, and that the market reacts favorably to repurchase announcements when employees have many unvested stock options. Managers are more likely to initiate share repurchases when employees hold a large stake in the firm. Moreover, since employees are forced to bear more risk in firms that repurchase shares, they exercise their stock options earlier and receive higher compensation.

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