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

Noe, Thomas (2009) Tunnel-proofing the executive suite: transparency, temptation, and the design of executive compensation. The Review of Financial Studies, 22 (12). pp. 4849-4880.

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 that 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.

Item Type: Article
Keywords: executive compensation; labour economics; finance
Subject(s): Finance
Date Deposited: 07 Nov 2011 16:25
Last Modified: 01 Mar 2017 12:02
Funders: N/A
URI: http://eureka.sbs.ox.ac.uk/id/eprint/1103

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