TY - JOUR
T1 - Options in Compensation: Promises and Pitfalls
AU - Flor, Christian Riis
AU - Frimor, Hans
AU - Munk, Claus
PY - 2014
Y1 - 2014
N2 - We derive the optimal compensation contract in a principal-agent setting in which outcome is used to provide incentives for both effort and risky investments. To motivate investment, optimal compensation entails rewards for high as well as low outcomes, and it is increasing at the mean outcome to motivate effort. If rewarding low outcomes is infeasible, compensation consisting of stocks and options is a near-efficient means of overcoming the manager's induced aversion to undertaking risky investments, whereas stock compensation is not. However, stock plus option compensation may induce excessively risky investments, and capping pay can be important in curbing such behavior.
AB - We derive the optimal compensation contract in a principal-agent setting in which outcome is used to provide incentives for both effort and risky investments. To motivate investment, optimal compensation entails rewards for high as well as low outcomes, and it is increasing at the mean outcome to motivate effort. If rewarding low outcomes is infeasible, compensation consisting of stocks and options is a near-efficient means of overcoming the manager's induced aversion to undertaking risky investments, whereas stock compensation is not. However, stock plus option compensation may induce excessively risky investments, and capping pay can be important in curbing such behavior.
U2 - 10.1111/1475-679X.12049
DO - 10.1111/1475-679X.12049
M3 - Journal article
SN - 0021-8456
VL - 52
SP - 703
EP - 732
JO - Journal of Accounting Research
JF - Journal of Accounting Research
IS - 3
ER -