Working Paper: CEPR ID: DP4878
Authors: Roman Inderst; Holger M. Müller
Abstract: Future wage payments drive a wedge between total firm output and the output share received by the firm?s owners, thus potentially distorting strategic decisions by the firm?s owners such as, e.g., whether to continue the firm, sell it, or shut it down. Using an optimal contracting approach, we show that the unique optimal firm-wide employee compensation scheme from this perspective is a broad-based option plan. Broad-based option pay minimizes the firm?s expected future wage payments in states of nature where the firm is only marginally profitable, thus making continuation as attractive as possible in precisely those states of nature where, e.g., a high fixed wage would lead the firm?s owners to inefficiently exit.
Keywords: broad option pay; employee stock options
JEL Codes: J31; J33
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| broadbased option pay (J33) | firm continuation decision (L21) |
| future wage payments (J33) | firm continuation decision (L21) |
| broadbased option pay (J33) | wage overhang problem (J31) |
| fixed wages (J33) | wage overhang problem (J31) |
| wage overhang problem (J31) | firm exit decision (G33) |
| broadbased option pay (J33) | strategic decision-making of firm owners (L21) |