NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Stock-Based Compensation and CEO (Dis)Incentives

Efraim Benmelech, Eugene Kandel, Pietro Veronesi

NBER Working Paper No. 13732
Issued in January 2008
NBER Program(s):   CF   LS

Stock-based compensation is the standard solution to agency problems between shareholders and managers. In a dynamic rational expectations equilibrium model with asymmetric information we show that although stock-based compensation causes managers to work harder, it also induces them to hide any worsening of the firm's investment opportunities by following largely sub-optimal investment policies. This problem is especially severe for growth firms, whose stock prices then become over-valued while managers hide the bad news to shareholders. We find that a firm-specific compensation package based on both stock and earnings performance instead induces a combination of high effort, truth revelation and optimal investments. The model produces numerous predictions that are consistent with the empirical evidence.

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Document Object Identifier (DOI): 10.3386/w13732

Published: Efraim Benmelech & Eugene Kandel & Pietro Veronesi, 2010. "Stock-Based Compensation and CEO (Dis)Incentives," The Quarterly Journal of Economics, MIT Press, vol. 125(4), pages 1769-1820, November. citation courtesy of

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