Executive Compensation, Incentives, and Risk
This paper analyzes the link between equity-based compensation and created incentives by (1) deriving a measure of incentives suitable for both linear and non-linear compensation contracts, (2) analyzing the effect of risk on incentives, and (3) clarifying the role of the agent's private tradin...
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| Format: | Working Paper |
| Language: | en_US |
| Published: |
2004
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| Online Access: | http://hdl.handle.net/1721.1/5068 |
| _version_ | 1826200462621147136 |
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| author | Jenter, Dirk |
| author_facet | Jenter, Dirk |
| author_sort | Jenter, Dirk |
| collection | MIT |
| description | This paper analyzes the link between equity-based compensation and created incentives by (1) deriving a measure of incentives suitable for both linear and non-linear compensation contracts, (2) analyzing the effect of risk on incentives, and (3) clarifying the role of the agent's private trading decisions in incentive creation. With option-based compensation contracts, the average pay-forperformance sensitivity is not an adequate measure of ex-ante incentives. Pay-for-performance covaries negatively with marginal utility and hence overstates the created incentives. Second, more noise in the performance measure implies that the manager is less certain about the effect of effort on performance, which in turn makes her less willing to exert effort. Finally, the private trading decisions by the manager have first-order effects on incentives. By reducing her holdings of the market asset, the manager achieves an effect similar to "indexing" the stock or option grant, making explicit indexation of the contract redundant. |
| first_indexed | 2024-09-23T11:36:51Z |
| format | Working Paper |
| id | mit-1721.1/5068 |
| institution | Massachusetts Institute of Technology |
| language | en_US |
| last_indexed | 2024-09-23T11:36:51Z |
| publishDate | 2004 |
| record_format | dspace |
| spelling | mit-1721.1/50682019-04-12T08:20:07Z Executive Compensation, Incentives, and Risk Jenter, Dirk executive compensation equity-based compensation created incentives This paper analyzes the link between equity-based compensation and created incentives by (1) deriving a measure of incentives suitable for both linear and non-linear compensation contracts, (2) analyzing the effect of risk on incentives, and (3) clarifying the role of the agent's private trading decisions in incentive creation. With option-based compensation contracts, the average pay-forperformance sensitivity is not an adequate measure of ex-ante incentives. Pay-for-performance covaries negatively with marginal utility and hence overstates the created incentives. Second, more noise in the performance measure implies that the manager is less certain about the effect of effort on performance, which in turn makes her less willing to exert effort. Finally, the private trading decisions by the manager have first-order effects on incentives. By reducing her holdings of the market asset, the manager achieves an effect similar to "indexing" the stock or option grant, making explicit indexation of the contract redundant. 2004-05-28T18:53:56Z 2004-05-28T18:53:56Z 2004-05-28T18:53:56Z Working Paper http://hdl.handle.net/1721.1/5068 en_US MIT Sloan School of Management Working Paper;4466-02 382354 bytes application/pdf application/pdf |
| spellingShingle | executive compensation equity-based compensation created incentives Jenter, Dirk Executive Compensation, Incentives, and Risk |
| title | Executive Compensation, Incentives, and Risk |
| title_full | Executive Compensation, Incentives, and Risk |
| title_fullStr | Executive Compensation, Incentives, and Risk |
| title_full_unstemmed | Executive Compensation, Incentives, and Risk |
| title_short | Executive Compensation, Incentives, and Risk |
| title_sort | executive compensation incentives and risk |
| topic | executive compensation equity-based compensation created incentives |
| url | http://hdl.handle.net/1721.1/5068 |
| work_keys_str_mv | AT jenterdirk executivecompensationincentivesandrisk |