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Stock-Based Compensation and CEO (Dis)Incentives

Efraim Benmelech, Eugene Kandel () and Pietro Veronesi

No 6515, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: Stock-based compensation is the standard solution to agency problems between shareholders and managers. In a dynamic rational expectations equilibrium model with asymmetric information we show that although stock-based compensation causes managers to work harder, it also induces them to hide any worsening of the firm’s investment opportunities by following largely sub-optimal investment policies. This problem is especially severe for growth firms, whose stock prices then become overvalued while managers hide the bad news to shareholders. We find that a firm-specific compensation package based on both stock and earnings performance instead induces a combination of high effort, truth revelation and optimal investments. The model produces numerous predictions that are consistent with the empirical evidence.

Keywords: CEO compensation; Sub-optimal investments (search for similar items in EconPapers)
JEL-codes: G31 G34 G35 (search for similar items in EconPapers)
Date: 2007-10
New Economics Papers: this item is included in nep-bec and nep-cfn
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Journal Article: Stock-Based Compensation and CEO (Dis)Incentives (2010) Downloads
Working Paper: Stock-Based Compensation and CEO (Dis)Incentives (2008) Downloads
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