IDEAS home Printed from https://ideas.repec.org/p/fmg/fmgdps/dp660.html
   My bibliography  Save this paper

The Optimal Timing of Executive Compensation

Author

Listed:
  • Pierre Chaigneau

Abstract

We propose a new continuous-time principal-agent model to study the optimal timing of stock-based incentives, when the effects of managerial actions materialize with a lag and are only progressively understood by shareholders. On the one hand, early contingent compensation hedges the manager against the accumulation of exogenous shocks. On the other hand, the fact that initial information asymmetries between the manager and shareholders are progressively resolved suggests that contingent compensation should be postponed. We introduce two possible types of managerial short-termism, and show that they both result in lower-powered incentives and more deferred compensation.

Suggested Citation

  • Pierre Chaigneau, 2010. "The Optimal Timing of Executive Compensation," FMG Discussion Papers dp660, Financial Markets Group.
    • Handle: RePEc:fmg:fmgdps:dp660
    as

    Download full text from publisher

    File URL: http://www.lse.ac.uk/fmg/workingPapers/discussionPapers/DP660_2010_Theoptimaltimingofexecutivecompensation.pdf
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Stein, Jeremy C, 1988. "Takeover Threats and Managerial Myopia," Journal of Political Economy, University of Chicago Press, vol. 96(1), pages 61-80, February.
    2. Kole, Stacey R., 1997. "The complexity of compensation contracts," Journal of Financial Economics, Elsevier, vol. 43(1), pages 79-104, January.
    3. Radner, Roy, 1981. "Monitoring Cooperative Agreements in a Repeated Principal-Agent Relationship," Econometrica, Econometric Society, vol. 49(5), pages 1127-1148, September.
    4. Bergstresser, Daniel & Philippon, Thomas, 2006. "CEO incentives and earnings management," Journal of Financial Economics, Elsevier, vol. 80(3), pages 511-529, June.
    5. Lacker, Jeffrey M & Weinberg, John A, 1989. "Optimal Contracts under Costly State Falsification," Journal of Political Economy, University of Chicago Press, vol. 97(6), pages 1345-1363, December.
    6. Burns, Natasha & Kedia, Simi, 2006. "The impact of performance-based compensation on misreporting," Journal of Financial Economics, Elsevier, vol. 79(1), pages 35-67, January.
    7. Shane A. Johnson & Harley E. Ryan & Yisong S. Tian, 2009. "Managerial Incentives and Corporate Fraud: The Sources of Incentives Matter," Review of Finance, European Finance Association, vol. 13(1), pages 115-145.
    8. Smith, Clifford Jr. & Watts, Ross L., 1992. "The investment opportunity set and corporate financing, dividend, and compensation policies," Journal of Financial Economics, Elsevier, vol. 32(3), pages 263-292, December.
    9. Brian J. Bushee & Theodore H. Goodman, 2007. "Which Institutional Investors Trade Based on Private Information About Earnings and Returns?," Journal of Accounting Research, Wiley Blackwell, vol. 45(2), pages 289-321, May.
    10. Marianne Bertrand & Sendhil Mullainathan, 2003. "Enjoying the Quiet Life? Corporate Governance and Managerial Preferences," Journal of Political Economy, University of Chicago Press, vol. 111(5), pages 1043-1075, October.
    11. Wang, Cheng, 1997. "Incentives, CEO Compensation, and Shareholder Wealth in a Dynamic Agency Model," Journal of Economic Theory, Elsevier, vol. 76(1), pages 72-105, September.
    12. Jean-Jacques Laffont & Jean Tirole, 1988. "Repeated Auctions of Incentive Contracts, Investment, and Bidding Parity with an Application to Takeovers," RAND Journal of Economics, The RAND Corporation, vol. 19(4), pages 516-537, Winter.
    13. Noah Williams, 2004. "On Dynamic Principal-Agent Problems in Continuous Time," Levine's Bibliography 122247000000000426, UCLA Department of Economics.
    14. Rüdiger Fahlenbrach, 2009. "Shareholder Rights, Boards, and CEO Compensation," Review of Finance, European Finance Association, vol. 13(1), pages 81-113.
    15. Patrick Bolton & José Scheinkman & Wei Xiong, 2006. "Executive Compensation and Short-Termist Behaviour in Speculative Markets," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 73(3), pages 577-610.
    16. Alex Edmans, 2009. "Blockholder Trading, Market Efficiency, and Managerial Myopia," Journal of Finance, American Finance Association, vol. 64(6), pages 2481-2513, December.
    17. Richardson, Vernon J & Waegelein, James F, 2002. "The Influence of Long-Term Performance Plans on Earnings Management and Firm Performance," Review of Quantitative Finance and Accounting, Springer, vol. 18(2), pages 161-183, March.
    18. Kaplan, Steven N, 1994. "Top Executive Rewards and Firm Performance: A Comparison of Japan and the United States," Journal of Political Economy, University of Chicago Press, vol. 102(3), pages 510-546, June.
    19. Jeremy C. Stein, 1989. "Efficient Capital Markets, Inefficient Firms: A Model of Myopic Corporate Behavior," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 104(4), pages 655-669.
    20. Vernon J. Richardson & James F. Waegelein, 2003. "Characteristics Associated with the Corporate Decision to Adopt Long‐term Performance Plans," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 30(3‐4), pages 621-644, April.
    21. Holmstrom, Bengt & Milgrom, Paul, 1991. "Multitask Principal-Agent Analyses: Incentive Contracts, Asset Ownership, and Job Design," The Journal of Law, Economics, and Organization, Oxford University Press, vol. 7(0), pages 24-52, Special I.
    22. Mehran, Hamid, 1995. "Executive compensation structure, ownership, and firm performance," Journal of Financial Economics, Elsevier, vol. 38(2), pages 163-184, June.
    23. Efendi, Jap & Srivastava, Anup & Swanson, Edward P., 2007. "Why do corporate managers misstate financial statements? The role of option compensation and other factors," Journal of Financial Economics, Elsevier, vol. 85(3), pages 667-708, September.
    24. O. Ashenfelter & D. Card (ed.), 1999. "Handbook of Labor Economics," Handbook of Labor Economics, Elsevier, edition 1, volume 3, number 3.
    25. Bizjak, John M. & Brickley, James A. & Coles, Jeffrey L., 1993. "Stock-based incentive compensation and investment behavior," Journal of Accounting and Economics, Elsevier, vol. 16(1-3), pages 349-372, April.
    26. Jensen, Michael C, 1986. "Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers," American Economic Review, American Economic Association, vol. 76(2), pages 323-329, May.
    27. Alex Edmans & Xavier Gabaix & Tomasz Sadzik & Yuliy Sannikov, 2009. "Dynamic Incentive Accounts," NBER Working Papers 15324, National Bureau of Economic Research, Inc.
    28. Ernst-Ludwig von Thadden, 1995. "Long-Term Contracts, Short-Term Investment and Monitoring," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 62(4), pages 557-575.
    29. Kumar, Raman & Sopariwala, Parvez R., 1992. "The Effect of Adoption of Long-Term Performance Plans on Stock Prices and Accounting Numbers," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 27(4), pages 561-573, December.
    30. Giannetti, Mariassunta, 2011. "Serial CEO incentives and the structure of managerial contracts," Journal of Financial Intermediation, Elsevier, vol. 20(4), pages 633-662, October.
    31. Steven N. Kaplan & Per Stromberg, 2001. "Venture Capitalists As Principals: Contracting, Screening, and Monitoring," NBER Working Papers 8202, National Bureau of Economic Research, Inc.
    32. Rafael La Porta & Florencio Lopez‐De‐Silanes & Andrei Shleifer, 1999. "Corporate Ownership Around the World," Journal of Finance, American Finance Association, vol. 54(2), pages 471-517, April.
    33. Kaplan, Steven, 1989. "The effects of management buyouts on operating performance and value," Journal of Financial Economics, Elsevier, vol. 24(2), pages 217-254.
    34. Parrino, Robert & Sias, Richard W. & Starks, Laura T., 2003. "Voting with their feet: institutional ownership changes around forced CEO turnover," Journal of Financial Economics, Elsevier, vol. 68(1), pages 3-46, April.
    35. Narayanan, M P, 1985. "Managerial Incentives for Short-term Results," Journal of Finance, American Finance Association, vol. 40(5), pages 1469-1484, December.
    36. Jean Tirole, 2006. "The Theory of Corporate Finance," Post-Print hal-00173191, HAL.
    37. Yuliy Sannikov, 2008. "A Continuous-Time Version of the Principal-Agent Problem," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 75(3), pages 957-984.
    38. Kaplan, Steven N. & Minton, Bernadette A., 2006. "How has CEO Turnover Changed? Increasingly Performance Sensitive Boards and Increasingly Uneasy CEOs," Working Papers 215, The University of Chicago Booth School of Business, George J. Stigler Center for the Study of the Economy and the State.
    39. Jensen, Michael C & Murphy, Kevin J, 1990. "Performance Pay and Top-Management Incentives," Journal of Political Economy, University of Chicago Press, vol. 98(2), pages 225-264, April.
    40. Phillip Leslie & Paul Oyer, 2008. "Managerial Incentives and Value Creation: Evidence from Private Equity," NBER Working Papers 14331, National Bureau of Economic Research, Inc.
    41. Vernon J. Richardson & James F. Waegelein, 2003. "Characteristics Associated with the Corporate Decision to Adopt Long-term Performance Plans," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 30(3-4), pages 621-644.
    42. Diamond, Douglas W & Verrecchia, Robert E, 1982. "Optimal Managerial Contracts and Equilibrium Security Prices," Journal of Finance, American Finance Association, vol. 37(2), pages 275-287, May.
    43. Larcker, David F., 1983. "The association between performance plan adoption and corporate capital investment," Journal of Accounting and Economics, Elsevier, vol. 5(1), pages 3-30, April.
    44. PETER M. DeMARZO & YULIY SANNIKOV, 2006. "Optimal Security Design and Dynamic Capital Structure in a Continuous‐Time Agency Model," Journal of Finance, American Finance Association, vol. 61(6), pages 2681-2724, December.
    45. Steven N. Kaplan & Bernadette Minton, 2006. "How has CEO Turnover Changed? Increasingly Performance Sensitive Boards and Increasingly Uneasy CEOs," NBER Working Papers 12465, National Bureau of Economic Research, Inc.
    46. Core, John & Guay, Wayne, 1999. "The use of equity grants to manage optimal equity incentive levels," Journal of Accounting and Economics, Elsevier, vol. 28(2), pages 151-184, December.
    47. Holmstrom, Bengt & Milgrom, Paul, 1987. "Aggregation and Linearity in the Provision of Intertemporal Incentives," Econometrica, Econometric Society, vol. 55(2), pages 303-328, March.
    48. Coles, Jeffrey L. & Daniel, Naveen D. & Naveen, Lalitha, 2006. "Managerial incentives and risk-taking," Journal of Financial Economics, Elsevier, vol. 79(2), pages 431-468, February.
    49. Holmstrom, Bengt & Tirole, Jean, 1993. "Market Liquidity and Performance Monitoring," Journal of Political Economy, University of Chicago Press, vol. 101(4), pages 678-709, August.
    50. Lin Peng & Ailsa Röell, 2008. "Executive pay and shareholder litigation," Review of Finance, European Finance Association, vol. 12(1), pages 141-184.
    51. Graham, John R. & Harvey, Campbell R. & Puri, Manju, 2013. "Managerial attitudes and corporate actions," Journal of Financial Economics, Elsevier, vol. 109(1), pages 103-121.
    52. Goldman, Eitan & Slezak, Steve L., 2006. "An equilibrium model of incentive contracts in the presence of information manipulation," Journal of Financial Economics, Elsevier, vol. 80(3), pages 603-626, June.
    53. Brickley, James A., 2003. "Empirical research on CEO turnover and firm-performance: a discussion," Journal of Accounting and Economics, Elsevier, vol. 36(1-3), pages 227-233, December.
    54. Bengt Holmström, 1999. "Managerial Incentive Problems: A Dynamic Perspective," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 66(1), pages 169-182.
    55. Steven N. Kaplan & Per Stromberg, 2001. "Venture Capitals As Principals: Contracting, Screening, and Monitoring," American Economic Review, American Economic Association, vol. 91(2), pages 426-430, May.
    56. Jay C. Hartzell & Laura T. Starks, 2003. "Institutional Investors and Executive Compensation," Journal of Finance, American Finance Association, vol. 58(6), pages 2351-2374, December.
    57. Shleifer, Andrei & Vishny, Robert W, 1990. "Equilibrium Short Horizons of Investors and Firms," American Economic Review, American Economic Association, vol. 80(2), pages 148-153, May.
    58. Bengt Holmström, 1999. "Managerial Incentive Problems: A Dynamic Perspective," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 66(1), pages 169-182.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Alex Edmans & Xavier Gabaix, 2016. "Executive Compensation: A Modern Primer," Journal of Economic Literature, American Economic Association, vol. 54(4), pages 1232-1287, December.
    2. Chaigneau, Pierre, 2018. "The optimal timing of CEO compensation," Finance Research Letters, Elsevier, vol. 24(C), pages 90-94.
    3. Carola Frydman & Dirk Jenter, 2010. "CEO Compensation," Annual Review of Financial Economics, Annual Reviews, vol. 2(1), pages 75-102, December.
    4. Taylan Mavruk & Evert Carlsson, 2015. "How long is a long-term-firm investment in the presence of governance mechanisms?," Eurasian Business Review, Springer;Eurasia Business and Economics Society, vol. 5(1), pages 117-149, June.
    5. Alex Edmans & Vivian W. Fang & Katharina A. Lewellen, 2013. "Equity Vesting and Managerial Myopia," NBER Working Papers 19407, National Bureau of Economic Research, Inc.
    6. Ferreira, Daniel & Athanasakou, Vasiliki & Goh, Lisa, 2017. "Changes in CEO Stock Option Grants: A Look at the Numbers," CEPR Discussion Papers 12318, C.E.P.R. Discussion Papers.
    7. Giannetti, Mariassunta, 2011. "Serial CEO incentives and the structure of managerial contracts," Journal of Financial Intermediation, Elsevier, vol. 20(4), pages 633-662, October.
    8. Gabaix, Xavier & Sannikov, Yuliy & Edmans, Alex & Sadzik, Tomasz, 2009. "Dynamic Incentive Accounts," CEPR Discussion Papers 7497, C.E.P.R. Discussion Papers.
    9. Edmans, Alex & Holderness, Clifford, 2016. "Blockholders: A Survey of Theory and Evidence," CEPR Discussion Papers 11442, C.E.P.R. Discussion Papers.
    10. Gao, Mingze & Leung, Henry & Qiu, Buhui, 2021. "Organization capital and executive performance incentives," Journal of Banking & Finance, Elsevier, vol. 123(C).
    11. Josef Schroth, 2018. "Managerial Compensation and Stock Price Manipulation," Journal of Accounting Research, Wiley Blackwell, vol. 56(5), pages 1335-1381, December.
    12. Armstrong, Christopher S. & Guay, Wayne R. & Weber, Joseph P., 2010. "The role of information and financial reporting in corporate governance and debt contracting," Journal of Accounting and Economics, Elsevier, vol. 50(2-3), pages 179-234, December.
    13. Athanasakou, Vasiliki & Ferreira, Daniel & Goh, Lisa, 2022. "Changes in CEO stock option grants: a look at the numbers," LSE Research Online Documents on Economics 115609, London School of Economics and Political Science, LSE Library.
    14. Alex Edmans, 2014. "Blockholders and Corporate Governance," Annual Review of Financial Economics, Annual Reviews, vol. 6(1), pages 23-50, December.
    15. Athanasakou, Vasiliki & Ferreira, Daniel & Goh, Lisa, 2022. "Changes in CEO stock option grants: A look at the numbers," Journal of Corporate Finance, Elsevier, vol. 75(C).
    16. Illoong Kwon & Katherine Guthrie & Jan Sokolowsky, 2008. "On the Objective of Corporate Boards: Theory and Evidence," Discussion Papers 08-08, University at Albany, SUNY, Department of Economics.
    17. Ingolf Dittmann & Ko-Chia Yu & Dan Zhang, 2017. "How Important Are Risk-Taking Incentives in Executive Compensation?," Review of Finance, European Finance Association, vol. 21(5), pages 1805-1846.
    18. Laux, Volker, 2012. "Stock option vesting conditions, CEO turnover, and myopic investment," Journal of Financial Economics, Elsevier, vol. 106(3), pages 513-526.
    19. Blanco, Iván & Wehrheim, David, 2017. "The bright side of financial derivatives: Options trading and firm innovation," Journal of Financial Economics, Elsevier, vol. 125(1), pages 99-119.
    20. Josef Schroth, 2015. "Managerial Compensation Duration and Stock Price Manipulation," Staff Working Papers 15-25, Bank of Canada.

    More about this item

    JEL classification:

    • G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance
    • J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods
    • M52 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Personnel Economics - - - Compensation and Compensation Methods and Their Effects

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:fmg:fmgdps:dp660. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: The FMG Administration (email available below). General contact details of provider: http://www.lse.ac.uk/fmg/ .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.