CEO’s incentive pay: it doesn’t work in practice, now it doesn’t work in theory

Why am I not surprised?

An interesting new article in the Nov 2010 QJE

Stock-Based Compensation and CEO (Dis)Incentives

Efraim Benmelech, Eugene Kandel, Pietro Veronesi

The use of stock-based compensation as a solution to agency problems between shareholders and managers has increased dramatically since the early 1990s. We show that in a dynamic rational expectations model with asymmetric information, stock-based compensation not only induces managers to exert costly effort, but also induces them to conceal bad news about future growth options and to choose suboptimal investment policies to support the pretense. This leads to a severe overvaluation and a subsequent crash in the stock price. Our model produces many predictions that are consistent with the empirical evidence and are relevant to understanding the current crisis.

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10 years ago

As Gomer Pyle would say: Surprise, surprise, surprise.

10 years ago

Excuse my ignorance. But does this mean that the “fat cats” will have to become cost effective, productive and honest? Surely that will put a lot of sociopaths out of work!
Question. How come it took this long and a GFC for the economic architects of the world to realise this? Should they be looking for a new line of work also?