Working Paper: CEPR ID: DP6422
Authors: Mariassunta Giannetti
Abstract: This paper analyzes the optimal contracting consequences of a recent phenomenon in the managerial labour market, CEO job hopping. I show that if the managerial labour market is thin and firm growth opportunities are weak, the optimal contract rewards the CEO for past performance through a bonus. Nevertheless, the CEO takes a long horizon in selecting corporate strategies. If firm growth opportunities improve, but prospects of job-hopping remain limited, the optimal contract includes restricted-equity-like claims, but overall compensation does not increase. However, if the managerial labour market provides more opportunities for job-hopping, large differences in the structure and the level of managerial compensation emerge. If firm growth opportunities are weak, it is optimal to offer a bonus contract, even though the CEO selects an inefficient short-term strategy. If firm growth opportunities are strong, a large amount of long-term equity compensation mitigates short-termist incentives. This drives a surge in CEO compensation. I show that, under these conditions, the optimal contract may include non-restricted equity even though the main problem is managerial retention. Finally, I argue that the model can explain both the surge in U.S. CEO compensation and the differences in managerial compensation across countries and across firms within a country.
Keywords: short-termism; executive compensation; managerial labour market
JEL Codes: G32; J33; L14
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| managerial labor market conditions (thin) and weak growth opportunities (J29) | short-term bonus contract (J33) |
| short-term bonus contract (J33) | efficient strategy selection (C61) |
| managerial labor market conditions (thick) and strong growth opportunities (J29) | long-term contracts with equity compensation (J33) |
| strong growth opportunities (O29) | larger shares of long-term output to incentivize value-enhancing strategies (D25) |
| CEO job-hopping (M12) | variations in managerial compensation structure (M52) |
| dynamics of managerial labor market conditions and firm growth opportunities (J29) | observed increases in CEO compensation (M12) |