Publication Type

Journal Article

Version

Preprint

Publication Date

10-2013

Abstract

We integrate an agency problem into search theory to study executive compensation in a market equilibrium. A CEO can choose to stay or quit and search after privately observing an idiosyncratic shock to the firm. The market equilibrium endogenizes CEOs’ and firms’ outside options and captures contracting externalities. We show that the optimal pay-to-performance ratio is less than one even when the CEO is risk neutral. Moreover, the equilibrium pay-to-performance sensitivity depends positively on a firm's idiosyncratic risk and negatively on the systematic risk. Our empirical tests using executive compensation data confirm these results.

Keywords

executive compensation, agency problem, chief executive officers, market equilibrium

Discipline

Corporate Finance | Human Resources Management

Research Areas

Finance

Publication

Journal of Finance

Volume

68

Issue

5

First Page

2001

Last Page

2058

ISSN

1540-6261

Identifier

10.1111/jofi.12069

Publisher

Wiley

Additional URL

http://dx.doi.org/10.1111/jofi.12069

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