Compensation for Managers with Career Concerns: The Role of Stock Options in Optimal Contracts

Posted: 30 Oct 2003

See all articles by Tom Nohel

Tom Nohel

Loyola University of Chicago

Steven K. Todd

Loyola University of Chicago

Abstract

We study the problem of compensating a manager whose career concerns affect his investment strategy. We consider contracts that include cash, shares, and call options, focusing on the role of options in aligning incentives. We find that managers are optimally paid in cash, supplemented by a small amount of call options; shares are excluded. The options are struck at-the-money, consistent with the near uniform practice of compensation committees. The convexity of option payoffs helps to overcome managerial conservatism, though a non-trivial under-investment problem persists. Our model yields several testable implications regarding cross-sectional variation in the size of option grants and pay-for-performance sensitivity.

Keywords: executive compensation, stock options, career concerns, pay-for-performance

JEL Classification: G31, G34, J33, L22

Suggested Citation

Nohel, Tom and Todd, Steven K., Compensation for Managers with Career Concerns: The Role of Stock Options in Optimal Contracts. Available at SSRN: https://ssrn.com/abstract=457000

Tom Nohel (Contact Author)

Loyola University of Chicago ( email )

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Chicago, IL 60611
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312-915-7065 (Phone)
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Steven K. Todd

Loyola University of Chicago ( email )

820 North Michigan Avenue
Chicago, IL 60611
United States
(312) 915-7218 (Phone)
(312) 915-8508 (Fax)

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