NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Executive Compensation and the Optimality of Managerial Entrenchment

Gary Gorton, Bruce D. Grundy

NBER Working Paper No. 5779
Issued in September 1996
NBER Program(s):   CF

Firms are more complicated than standard principal-agent theory allows: firms have assets-in-place; firms endure through time, allowing for the possibility of replacing a shirking manager; firms have many managers, constraining the amount of equity that can be awarded to any one manager; and, a firm's owner can transfer some control to a manager, thereby entrenching her. Recognizing these characteristics, we solve for the vesting dates; wage, equity and options components; and control rights of an optimal contract. Managerial entrenchment makes the promise of deferred compensation credible. Deferring compensation by delaying vesting reduces a manager's ability to free-ride on a replacement's effort.

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Document Object Identifier (DOI): 10.3386/w5779

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