The Optimal Duration of Executive Compensation: Theory and Evidence
CEAR Seminar Room – RCB 1120 – from 2:00 – 4:30
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 and strong empirical support using our measure of pay duration. First, optimal pay duration is decreasing in the extent of mispricing of the rm’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.