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Stock Grants as a Commitment Device

by Gian Luca Clementi, Tom Cooley, and Cheng Wang

Journal of Economic Dynamics and Control, Volume 30, Issue 11, November 2006, pages 2191-2216

Paper (PDF Format)


A large and increasing fraction of the value of executives' compensation is accounted for by security grants. However, in most models of executive compensation, the optimal allocation can be implemented through a sequence of state-contingent cash payments. Security awards are redundant. In this paper we develop a dynamic model of managerial compensation where neither the firm nor the manager can commit to long-term contracts. We show that, in this environment, if stock grants are not used, then the optimal contract collapses to a series of short term contracts. When stock grants are used, however, nonlinear intertemporal schemes can be implemented to achieve better risk-sharing and higher firm value.

Working paper version available at Repec