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Optimal CEO turnover

Author

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  • Wang, Cheng
  • Yang, Youzhi

Abstract

We study a dynamic principal-agent/firm-CEO relationship that is subject simultaneously to moral hazard, limited commitment, and shocks to the CEO's market value. Termination is used as (a) an incentive instrument to punish the CEO for bad performance, (b) a cost minimization device that uses the CEO's outside value as an external means for compensation, and (c) as a means for replacing the incumbent CEO with a less expensive new CEO. Termination occurs after the CEO receives either a sufficiently high or a sufficiently low outside value. The model generates both voluntary and involuntary/forced turnovers, and counter-offers occur on the equilibrium path. The model is calibrated to the U.S. data to capture the key observed features of CEO pay and turnover. It shows that increased moral hazard offers an explanation for the observed increase in the level and variance of CEO compensation, as well as the increase in forced CEO turnover.

Suggested Citation

  • Wang, Cheng & Yang, Youzhi, 2022. "Optimal CEO turnover," Journal of Economic Theory, Elsevier, vol. 203(C).
    • Handle: RePEc:eee:jetheo:v:203:y:2022:i:c:s0022053122000655
    DOI: 10.1016/j.jet.2022.105475
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    References listed on IDEAS

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    More about this item

    Keywords

    Optimal contracting; Moral hazard; Outside option; Limited commitment; CEO compensation and turnover;
    All these keywords.

    JEL classification:

    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • J63 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - Turnover; Vacancies; Layoffs
    • M12 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Business Administration - - - Personnel Management; Executives; Executive Compensation

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