Affiliation:
1. Department of Economics, Stockholm School of Economics, S–11383 Stockholm, Sweden;
2. Norwegian School of Economics, N–5045 Bergen, Norway
Abstract
We propose a model of how the retention motive shapes managerial compensation contracts. Once employed, a risk-averse manager acquires imperfectly portable skills whose value is stochastic because of industry-wide demand shocks. The manager’s actions are uncontractible, and the perceived fairness of the compensation contract affects the manager’s motivation. If the volatility of profits is sufficiently large and outside offers are sufficiently likely, the equilibrium contract combines a salary with an own-firm stock option. The model’s predictions are consistent with empirical regularities concerning contractual shape, the magnitude of variable pay, the lack of indexation, and the prevalence of discretionary severance pay. This paper was accepted by Axel Ockenfels, behavioral economics and decision analysis.
Publisher
Institute for Operations Research and the Management Sciences (INFORMS)
Subject
Management Science and Operations Research,Strategy and Management
Cited by
2 articles.
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