Working Paper: CEPR ID: DP5713
Authors: Roman Inderst; Holger M. Mueller
Abstract: This paper considers the joint optimal design of CEOs' on-the-job compensation and severance pay in a general optimal contracting framework. We obtain a novel argument for high-powered, non-linear CEO compensation such as bonus schemes and option grants that is different from existing arguments based on moral hazard and risk taking. Based on this argument, the CEO's optimal on-the-job compensation scheme is designed to minimize the use of costly severance pay to reduce CEO entrenchment, thus minimizing the CEO's informational rents. Our model generates novel empirical predictions concerning the interrelation of CEOs' on-the-job compensation and severance pay as well as CEO turnover which, to the extent that they have been tested, are consistent with the empirical evidence.
Keywords: CEO compensation; entrenchment; stock options
JEL Codes: D82; D86; G34
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| CEO compensation schemes (M12) | CEO entrenchment behaviors (G34) |
| CEO entrenchment behaviors (G34) | likelihood of strategy changes (C73) |
| severance pay (J65) | CEO entrenchment behaviors (G34) |
| increases in severance pay (J65) | likelihood of strategy changes (C73) |
| high-powered nonlinear compensation schemes (C61) | CEO entrenchment (G34) |
| high severance pay (J65) | CEO entrenchment (G34) |
| CEO compensation and severance pay (M12) | CEO turnover (M12) |
| firm volatility (G32) | severance and compensation packages (J65) |