Chaigneau, Pierre
(2009)
Essays on CEO compensation.
PhD thesis, London School of Economics and Political Science.
Abstract
This thesis analyzes CEO compensation contracts in a principal-agent framework with moral hazard. It focuses on two issues: the form and the timing of performance-based pay. On the one hand, if CEOs are assumed to be mean-variance maximizers, I show that it is suboptimal to provide incentives with contracts which are convex in performance. This is because these contracts make the variance of pay an increasing function of the CEO's effort, which is inefficient. Sticks are more efficient than carrots, although the latter may be used in case the agent is protected by limited liability. On the other hand, if CEOs are assumed to be not only risk averse but also prudent, convex contracts and rewards may be optimal, since they protect against downside risk. A calibration of a HARA-lognormal model shows that CEO preferences which minimize the suboptimality of the typically observed contracts (relative to the optimal contract) feature decreasing absolute risk aversion, as well as low and decreasing relative risk aversion. However, when CEO pay is contingent on a lognormally distributed stock price, it is hard to rationalize the use of convex contracts for incentive provision. The thesis then examines the optimal evaluation and payment date, when the CEO's actions materialize with a lag. Information asymmetries are progressively resolved: the precision of signals that shareholders receive regarding the final outcome is increasing with time. However, the accumulation of exogenous shocks make deferred compensation noisy. The optimal timing of CEO pay, which minimizes the extent of the mispricing at the payment date, is derived. Opportunities for two types of managerial short-termism are then introduced. To ensure that the manager does not engage in short-termist and inefficient behavior, it is often optimal to reduce the power of incentives, and to postpone the evaluation and payment date.
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