Executive Compensation: A General Equilibrium Perspective

Jean-Pierre Danthine and John Donaldson
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John Donaldson: Columbia University

Review of Economic Dynamics, 2015, vol. 18, issue 2, 269-286

Abstract: We study the dynamic general equilibrium of an economy where risk averse shareholders delegate the management of the firm to risk averse managers. The optimal contract has two main components: an incentive component corresponding to a non-traded equity position and a variable "salary" component indexed to the aggregate wage bill and to aggregate dividends. Tying a manager's compensation to the performance of her own firm ensures that her interests are aligned with the goals of firm owners and that maximizing the discounted sum of future dividends will be her objective. Linking managers' compensation to overall economic performance is also required to make sure that managers use the appropriate stochastic discount factor to value those future dividends. General equilibrium considerations thus provide a potential resolution of the "pay for luck" puzzle. We also demonstrate that one sided "relative performance evaluation" follows equally naturally when managers and shareholders display differential risk averse. (Copyright: Elsevier)

Keywords: Incentives; Optimal contracting; Stochastic discount factor; Pay-for-luck; Relative performance (search for similar items in EconPapers)
JEL-codes: E32 E44 (search for similar items in EconPapers)
Date: 2015
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Citations: View citations in EconPapers (4)

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DOI: 10.1016/j.red.2014.04.003

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