TY - JOUR AU - Edmans,Alex AU - Gabaix,Xavier AU - Sadzik,Tomasz AU - Sannikov,Yuliy TI - Dynamic Incentive Accounts JF - National Bureau of Economic Research Working Paper Series VL - No. 15324 PY - 2009 Y2 - September 2009 DO - 10.3386/w15324 UR - http://www.nber.org/papers/w15324 L1 - http://www.nber.org/papers/w15324.pdf N1 - Author contact info: Alex Edmans The Wharton School University of Pennsylvania 2460 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 Tomasz Sadzik Department of Economics 19 West 4 Street, Suite 612 New York, NY 10012 E-Mail: tsadzik@nyu.edu Yuliy Sannikov Department of Economics 208 Fisher Hall Princeton University Princeton, NJ 08544 E-Mail: sannikov@gmail.com AB - Contracts in a dynamic model must address a number of issues absent from static frameworks. Shocks to firm value may weaken the incentive effects of securities (e.g. cause options to fall out of the money), and the impact of some CEO actions may not be felt until far in the future. We derive the optimal contract in a setting where the CEO can affect firm value through both productive effort and costly manipulation, and may undo the contract by privately saving. The optimal contract takes a surprisingly simple form, and can be implemented by a "Dynamic Incentive Account." The CEO's expected pay is escrowed into an account, a fraction of which is invested in the firm's stock and the remainder in cash. The account features state-dependent rebalancing and time-dependent vesting. It is constantly rebalanced so that the equity fraction remains above a certain threshold; this threshold sensitivity is typically increasing over time even in the absence of career concerns. The account vests gradually both during the CEO's employment and after he quits, to deter short-termist actions before retirement. ER -