TY - JOUR AU - Edmans,Alex AU - Gabaix,Xavier AU - Landier,Augustin TI - A Calibratable Model of Optimal CEO Incentives in Market Equilibrium JF - National Bureau of Economic Research Working Paper Series VL - No. 13372 PY - 2007 Y2 - September 2007 UR - http://www.nber.org/papers/w13372 L1 - http://www.nber.org/papers/w13372.pdf N1 - Author contact info: Alex Edmans The Wharton School University of Pennsylvania 2318 Steinberg Hall - Dietrich Hall 3620 Locust Walk Philadelphia, PA 19104 Tel: 215/746-0498 Fax: 215/898-6200 E-Mail: aedmans@wharton.upenn.edu Xavier Gabaix New York University Finance Department Stern School of Business 44 West 4th Street, 9th floor New York, NY 10012 Tel: 212-998-0257 Fax: 212-995-4233 E-Mail: xgabaix@stern.nyu.edu Augustin Landier the Toulouse School of Economics 21 Allée de Brienne 31000 Toulouse, FRANCE E-Mail: augustin.landier@tse-fr.eu AB - This paper presents a unified framework for understanding the determinants of both CEO incentives and total pay levels in competitive market equilibrium. It embeds a modified principal-agent problem into a talent assignment model to endogenize both elements of compensation. The model's closed form solutions yield testable predictions for how incentives should vary across firms under optimal contracting. In particular, our calibrations show that the negative relationship between the CEO's effective equity stake and firm size is quantitatively consistent with efficiency and need not reflect rent extraction. Our model and data both also imply that the dollar change in wealth for a percentage change in firm value, scaled by annual pay, is independent of firm size. This may render it an attractive incentive measure as it is comparable between firms and over time. The theory also predicts a positive relationship between pay volatility and firm volatility, and that risk and effort affect total pay along the cross-section but not in the aggregate. Finally, we demonstrate that incentive compensation is effective at solving large agency problems, such as selecting corporate strategy, but smaller issues such as perk consumption are best addressed through direct monitoring. ER -