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Incentive Pay that Causes Inefficient Managerial Replacement

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  • Meg Adachi-Sato

    (School of Economics, Finance and Marketing, Royal Melbourne Institute of Technology University)

Abstract

　　 Using contract theory, this article considers the effect of stock-based compensation on managerial replacement. I show that while stock-based compensation solves the moral hazard problem, it creates a distortion in the principal's managerial replacement decisions. Specifically, I show the principal endogenously determines the agent's tenure in a way that maximizes her own expected payoff, where her rational choice to replace or retain the incumbent agent may depart from the total firm value maximization. I find that along the parametric range of control benefit, both long- and short-term vested stock options may exhibit over-replacement of the incumbent agent, but in some cases, long-term vested options may cause more ine¢ ciency than short-term vested options. The article also indicates that only the short-term vested options may exhibit under-replacement. Journal of Economic Literature Classifications:

Suggested Citation

  • Meg Adachi-Sato, 2013. "Incentive Pay that Causes Inefficient Managerial Replacement ," CIRJE F-Series CIRJE-F-890, CIRJE, Faculty of Economics, University of Tokyo.
    • Handle: RePEc:tky:fseres:2013cf890
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    File URL: http://www.cirje.e.u-tokyo.ac.jp/research/dp/2013/2013cf890.pdf
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    References listed on IDEAS

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    Cited by:

    1. Meg Adachi-Sato, 2015. "Insular Decision Making in the Board Room: Why Boards Retain and Hire Substandard CEOs," Manchester School, University of Manchester, vol. 83(2), pages 183-216, March.

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