The Optimal Duration of Executive Compensation: Theory and Evidence

Authors

Radhakrishnan Gopalan, Washington University in St. Louis - John M. Olin Business SchoolFollow
Todd T. Milbourn, Southern Methodist University (SMU) - SMU Cox School of BusinessFollow
Fenghua Song, Pennsylvania State University - Smeal College of BusinessFollow
Anjan V. Thakor, Washington University in St. Louis - John M. Olin Business School; Financial Theory Group; European Corporate Governance Institute (ECGI); Massachusetts Institute of Technology (MIT) - Laboratory for Financial EngineeringFollow

Publication Date

8-10-2010

Abstract

While much is made of the ills of “short-termism” in executive compensation, in reality very little is known empirically about the extent of short-termism in CEO compensation. This paper develops a new measure of CEO pay duration that reflects the vesting periods of different components of compensation, thereby quantifying the extent to which compensation is short-term and the extent to which it is long-term. It also develops a theoretical model that generates three predictions for which we find strong empirical support using our measure of pay duration. First, optimal pay duration is decreasing in the extent of mispricing of the firm’s stock. Second, optimal pay duration is longer in firms with poorer corporate governance. Third, CEOs with shorter pay durations are more likely to engage in myopic investment behavior, and this relationship is stronger when the extent of stock mispricing is larger.

Document Type

Article

Keywords

Executive Compensation, Vesting, Duration, Managerial Myopia, Corporate Governance

Disciplines

Finance

DOI

10.2139/ssrn.1656603

Source

SMU Cox: Finance (Topic)

Language

English