Sticks or carrots? Optimal CEO compensation when managers are loss-averse

I. Dittmann, E. Maug, O.G. Spalt

Research output: Contribution to journalArticleScientificpeer-review

Abstract

This paper analyzes optimal executive compensation contracts when managers are loss averse. We calibrate a stylized principal-agent model to the observed contracts of 595 CEOs and show that this model can explain observed option holdings and high base salaries remarkably well for a range of parameterizations. We also derive and calibrate the general shape of the optimal contract that is increasing and convex for medium and high outcomes and that drops discontinuously to the lowest possible payout for low outcomes. Finally, we identify the critical features of the loss-aversion model that render optimal contracts convex.
Original languageEnglish
Pages (from-to)2015-2050
JournalJournal of Finance
Volume65
Issue number6
Publication statusPublished - 2010

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CEO compensation
Managers
Optimal contract
Chief executive officer
Payout
Loss aversion
Executive compensation
Salary
Principal-agent model

Cite this

Dittmann, I., Maug, E., & Spalt, O. G. (2010). Sticks or carrots? Optimal CEO compensation when managers are loss-averse. Journal of Finance, 65(6), 2015-2050.
Dittmann, I. ; Maug, E. ; Spalt, O.G. / Sticks or carrots? Optimal CEO compensation when managers are loss-averse. In: Journal of Finance. 2010 ; Vol. 65, No. 6. pp. 2015-2050.
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Dittmann, I, Maug, E & Spalt, OG 2010, 'Sticks or carrots? Optimal CEO compensation when managers are loss-averse', Journal of Finance, vol. 65, no. 6, pp. 2015-2050.

Sticks or carrots? Optimal CEO compensation when managers are loss-averse. / Dittmann, I.; Maug, E.; Spalt, O.G.

In: Journal of Finance, Vol. 65, No. 6, 2010, p. 2015-2050.

Research output: Contribution to journalArticleScientificpeer-review

TY - JOUR

T1 - Sticks or carrots? Optimal CEO compensation when managers are loss-averse

AU - Dittmann, I.

AU - Maug, E.

AU - Spalt, O.G.

PY - 2010

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N2 - This paper analyzes optimal executive compensation contracts when managers are loss averse. We calibrate a stylized principal-agent model to the observed contracts of 595 CEOs and show that this model can explain observed option holdings and high base salaries remarkably well for a range of parameterizations. We also derive and calibrate the general shape of the optimal contract that is increasing and convex for medium and high outcomes and that drops discontinuously to the lowest possible payout for low outcomes. Finally, we identify the critical features of the loss-aversion model that render optimal contracts convex.

AB - This paper analyzes optimal executive compensation contracts when managers are loss averse. We calibrate a stylized principal-agent model to the observed contracts of 595 CEOs and show that this model can explain observed option holdings and high base salaries remarkably well for a range of parameterizations. We also derive and calibrate the general shape of the optimal contract that is increasing and convex for medium and high outcomes and that drops discontinuously to the lowest possible payout for low outcomes. Finally, we identify the critical features of the loss-aversion model that render optimal contracts convex.

M3 - Article

VL - 65

SP - 2015

EP - 2050

JO - The Journal of Finance

JF - The Journal of Finance

SN - 0022-1082

IS - 6

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