Dynamic CEO Compensation

Authors

  • ALEX EDMANS,

  • XAVIER GABAIX,

  • TOMASZ SADZIK,

  • YULIY SANNIKOV

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    • Edmans is from The Wharton School, University of Pennsylvania, NBER, and ECGI; Gabaix is from the NYU Stern School of Business, NBER, CEPR, and ECGI; Sadzik is from New York University; and Sannikov is from Princeton University. For helpful comments, we thank an anonymous referee, an Associate Editor, the Editor (Cam Harvey), Raj Aggarwal, Gary Becker, Gilles Chemla, Ingolf Dittmann, Phil Dybvig, Oliver Hart, Ken Feinberg, Mike Fishman, Christian Goulding, Zhiguo He, Marcus Opp, Tomasz Piskorski, Ailsa Roell, Leonid Spesivtsev, Ajay Subramaniam, Eric Talley, and seminar participants at the AEA, Conference on Financial Economics and Accounting, Financial Research Association, FIRS, Harvard Law School/Sloan Foundation Conference on Corporate Governance, Jackson Hole Finance Conference, LSE FMG Conference on Managers, Incentives and Organizational Structure, NBER Corporate Finance, NBER Law and Economics, Paris Corporate Finance Conference, Society for Economic Dynamics, Washington University Conference on Corporate Finance, WFA, Arizona State, Caltech, Chicago, Colorado, Harvard, Northwestern, NYU, Toulouse, and Wharton. Qi Liu and Andrei Savotchkine provided excellent research assistance. This paper was previously circulated under the title “Dynamic Incentive Accounts.”


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.

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