Benefits of Broad-based Option Pay

Roman Inderst and Holger Mueller

No 4878, CEPR Discussion Papers from Centre for Economic Policy Research

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 (search for similar items in EconPapers)
JEL-codes: J31 J33 (search for similar items in EconPapers)
Date: 2005-01
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Citations: View citations in EconPapers (5)

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