Essays On Executive Compensation.

Overview

The agency problem between a shareholder and the chief executive officer---henceforth CEO---is studied, when the CEO privately chooses not only the effort level but also the firm's main investment project. While considerable attention has been paid to the optimal compensation contract when effort level is not observable, the effect of an unobservable project choice has been comparatively neglected. This is not entirely surprising. If selecting an investment project does not impose a cost on the CEO---as exerting ...
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More About This Book

Overview

The agency problem between a shareholder and the chief executive officer---henceforth CEO---is studied, when the CEO privately chooses not only the effort level but also the firm's main investment project. While considerable attention has been paid to the optimal compensation contract when effort level is not observable, the effect of an unobservable project choice has been comparatively neglected. This is not entirely surprising. If selecting an investment project does not impose a cost on the CEO---as exerting effort does---there is seemingly no conflict of interest between the CEO and the shareholder. Thus, it stands to reason that project choice would not be an important variable in designing compensation contracts. It is demonstrated in this dissertation that the relative neglect of project choice is unwarranted and showed how compensation packages must be modified to account for investment decisions. There are two main parts to the analysis. First, a model is developed. In that model the firm's potential directions are alternative investment projects characterized by their expected return and risk. It is assumed that both actions, effort level and project choice, are unobservable by the shareholder. There is, however, a clear asymmetry between project choice and effort level: choosing an investment project does not impose a direct cost on the CEO while exerting effort to implement the chosen project does. The optimal compensation contract to use is identified and it is showed that ignoring project choice in the design of compensation packages leads to significant inefficiencies. Second, an empirical analysis is performed. It does not test the theoretic model but rather complements it. A simultaneous equation model with panel data and fixed effects is used to investigate the relationship between compensation incentives and the firm's risk level. It may be argued that if the CEO's incentives are strongly aligned to the firm's profitability, the CEO might become too conservative, from the shareholder's viewpoint, in making investment decisions. The regression results are consistent with this position in the sense that low sensitivity (to profitability) of the CEO's compensation, may reflect the shareholder's concern.
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Product Details

  • ISBN-13: 9781243557094
  • Publisher: BiblioLabsII
  • Publication date: 9/3/2011
  • Pages: 82
  • Product dimensions: 7.44 (w) x 9.69 (h) x 0.17 (d)

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