Incentive Pay that Causes Inefficient Managerial Replacement

Meg Adachi-Sato
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Meg Adachi-Sato: School of Economics, Finance and Marketing, Royal Melbourne Institute of Technology University

No CIRJE-F-890, CIRJE F-Series from CIRJE, Faculty of Economics, University of Tokyo

Abstract: 　　 Using contract theory, this article considers the effect of stock-based compensation on managerial replacement. I show that while stock-based compensation solves the moral hazard problem, it creates a distortion in the principal's managerial replacement decisions. Specifically, I show the principal endogenously determines the agent's tenure in a way that maximizes her own expected payoff, where her rational choice to replace or retain the incumbent agent may depart from the total firm value maximization. I find that along the parametric range of control benefit, both long- and short-term vested stock options may exhibit over-replacement of the incumbent agent, but in some cases, long-term vested options may cause more ine¢ ciency than short-term vested options. The article also indicates that only the short-term vested options may exhibit under-replacement. Journal of Economic Literature Classifications:

Pages: 47 pages
Date: 2013-06
New Economics Papers: this item is included in nep-cta, nep-hrm, nep-lma and nep-ppm
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:tky:fseres:2013cf890

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