Tunnel-proofing the executive suite: temptation, and the design of executive compensation

Thomas Noe ()

OFRC Working Papers Series from Oxford Financial Research Centre

Abstract: This paper considers optimal compensation for a CEO who is entrusted with administering corporate assets honestly. Optimal compensation designs maximize integrity at minimum cost. These designs are very ‘low powered,’ i.e., while specifying a lower bound for performance and increasing pay with performance, they increase compensation at a rapidly decreasing rate. Thus, integrity considerations engender optimal compensation packages that closely resemble the very pervasive 80/120 bonus plans, exactly the sort of compensation which Jensen (2003) argues should compromise integrity. Under optimal designs, expected compensation increases linearly with firm size, and increases in the market/book ratio. Moreover, given optimal compensation, CEO asset diversion is limited to high market-to-book firms that have received negative productivity shocks.

Keywords: incentives; managerial compensation; agency (search for similar items in EconPapers)
Pages: 20
Date: 2008
New Economics Papers: this item is included in nep-bec and nep-cta
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Persistent link: https://EconPapers.repec.org/RePEc:sbs:wpsefe:2008fe13

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