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

Noe, Thomas (2004) Tunnel-proofing the executive suite: transparency, temptation, and the design of executive compensation. In: Western Finance Association Conference, 26 June 2004, Vancouver, Canada.

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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: Conference or Workshop Item (Paper)
Keywords: Executive compensation; Labour economics
Subject(s): Finance
Centre: Faculty of Finance
Date Deposited: 26 Feb 2012 18:05
Last Modified: 23 Oct 2015 14:07
URI: http://eureka.sbs.ox.ac.uk/id/eprint/2909

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