Stock Grants as Commitment Device

Gian Luca Clementi, Thomas Cooley and Cheng Wang

No 2002-E12, GSIA Working Papers from Carnegie Mellon University, Tepper School of Business

Abstract: A large and increasing fraction of the value of executives' compensation is accounted for by security grants. It is often argued that the optimal compensation contracts characterized in the theoretical literature can be implemented by means of stock or option grants. However, in most cases the optimal allocation can be implemented simply by a contingent sequence of cash payments. Security awards are redundant. In this paper we develop a dynamic model of managerial compensation where neither the firm nor the manager can commit to long-term contracts. We show that, in this environment, if stock grants are not used, then the optimal contract collapses to a series of short term contracts. When stock grants are used, however, nonlinear intertemporal schemes can be implemented to achieve better risk-sharing and larger firm value.

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Related works:
Journal Article: Stock grants as a commitment device (2006)
Working Paper: Stock Grants As a Commitment Device (2006)
Working Paper: Stock Grants as a Committment Device (2004)
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