Work

Sticks or Carrots? Optimal CEO Compensation when Managers Are Loss Averse

Year: 2010

Type: article

Abstract: ABSTRACT This paper analyzes optimal executive compensation contracts when managers are loss averse. We calibrate a stylized principal‐agent model to the observed contracts of 595 CEOs and show that this model can explain observed option holdings and high base salaries remarkably well for a range of parameterizations. We also derive and calibrate the general shape of the optimal contract that is increasing and convex for medium and high outcomes and that drops discontinuously to the lowest possible payout for low outcomes. Finally, we identify the critical features of the loss‐aversion model that render optimal contracts convex.

Source: The Journal of Finance

DOI: 10.1111/j.1540-6261.2010.01609.x

Authors: INGOLF DITTMANN, ERNST MAUG, OLIVER SPALT

Institutions: Erasmus University Rotterdam, University of Mannheim, Tilburg University, European Accounting Association

Language: English

Topic: Corporate Finance and Governance

Subfield: Finance

Field: Economics, Econometrics and Finance

Domain: Social Sciences

Open Access status: green

Funder: Nederlandse Organisatie voor Wetenschappelijk Onderzoek

Award: Explaining stock options in executive compensation