This paper summarizes the empirical and theoretical research on executive compensation and provides a comprehensive and up-to-date description of pay practices (and trends in pay practices) for chief executive officers (CEOs). Topics discussed include the level and structure of CEO pay (including detailed analyses of annual bonus plans, executive stock options, and option valuation), international pay differences, the pay-setting process, the relation between CEO pay and firm performance (“pay-performance sensitivities”), the relation between sensitivities and subsequent firm performance, relative performance evaluation, executive turnover, and the politics of CEO pay.

This paper studies how firms tie CEO compensation to firms' stock market performance. I demonstrate that in theory and in practice there is a tradeo# between giving CEOs incentives and forcing them to hold an un-diversified position in the firm. Unlike the results of the existing literature, market risk is not necessarily a cost of providing incentives. The cost of giving incentives is the potential loss of diversification for the CEO. As a result, CEO incentive decreases with firm-specific risk, but may not decrease with market risk. In performing the empirical tests, I also incorporate the recent critique by Prendergast (2000), which argues that the relation between risk and incentive level is unreliably estimated when we fail to consider the effect of risk on the benefit of giving incentives. I study both sides of the incentive-diversification tradeoff simultaneously. I am able to show that after controlling for the other side of the tradeoff, incentive increases with the CEOs' ability to affect firm value, and decreases with the firm-specific risk level of the firm.

This paper extends the investigation of the effect of managerial motives on hedging policy. I utilize a proxy variable that incorporates CEO incentives to increase risk versus stock price. The variable is directly measured using the characteristics of CEO portfolios of stock and option holdings. Furthermore, CEO risk-taking incentives are modeled as a choice variable to eliminate the simultaneity bias of modeling risk-taking incentives as an exogenous variable. CEO risk-taking incentives are negatively related to net derivative holdings for a large cross-sectional sample of firms. This effect is only weakly apparent in one-stage models of risk management. If modeled as a simultaneous system of equations, a strong negative link between CEO risk-taking incentives and the amount of derivative holdings exists. This result is consistent with the notion that derivatives are used for hedging purposes. Both the characteristics of stock and option holdings are important in determining cross-sectional differences in corporate derivative holdings.

We examine how different economies would design an optimal corporate governance system structured from three of the main mechanisms of corporate governance (managerial ownership, monitoring by banks, and disciplining by the takeover market). We allow for interactions among the mechanisms. The first set of results characterizes the combination of governance mechanisms that can appear in any optimally designed structure: 1) when monitored debt appears in an optimal system it is accompanied by concentrated ownership, and 2) when takeovers appear in an optimal system they are accompanied by diffuse ownership. We show that out of the numerous governance structures that could arise from combinations of the governance mechanisms, only three are candidates for an optimal system. These three endogenously derived governance structures match the prevalent systems (family based, bank based and market based) in the world. The optimal system for a given economy is characterized as a function of the degrees of development of its financial institutions and markets. Our analysis yields several testable implications. 1

In a sample of 200 large Nasdaq firms we examine the determinants of stock option grants and study whether options are associated with superior firm performance. We find that firms grant options in the face of financial constraints, to give incentives to increase firm value, and to hire and retain employees. We further find that grant of options to retain key employees and to relax financial constraints increases firm value and results in positive abnormal returns. However, there is little evidence that option grants to align employee incentives in high growth firms results in superior performance. There also exists some evidence that difficulty in the estimation of the true cost of stock options results in over estimation of firm value and abnormal returns, though this effect is confined only to the case when Fama-French size and book-to-market portfolios are used as reference portfolios. 1 We would like to thank Luann Lynch and Peter Suzman for clarifying conversations and Michael Fedirici for help in collecting and organizing the data. We also thank seminar participants at Cap Gemini Ernst & Young Group, Boston University, and Darden School, University of Virginia. We gratefully acknowledge financial support from

This paper is based on a chapter entitled `Swaps, Default Risk and the Corporate Hedging Motive ' from my PhD dissertation at New York University. I am grateful to the anonymous JFQA referee for exceptionally

Numerous theoretical models show how management incentive schemes can reduce the distortionary effects of financial leverage. However, there is little empirical support for the models ’ prediction that highly levered firms should offer less stock-based compensation. We stress that the incentive effects of financial leverage can be directly offset by adjusting the exercise price of executive stock options, and that the standard practice of setting exercise prices near the prevailing stock price accomplishes much of the necessary adjustment. In a large sample of Canadian option-granting firms, we find no evidence that risk-taking incentives are increased by financial leverage. This is true both cross-sectionally and over time. JEL Classification Numbers G32, D23, J33Financial structure can affect real decisions through two distinct channels. First, debt obligations restrict the flow of funds into the firm 1. Second, as argued by Jensen and Meckling (1976), financial leverage induces shareholders to favor risky projects even if such projects reduce total firm value. 2 Haugen and Senbet (1981) were the first to point out that financial leverage will not distort risk choices if managers ’ incentives differ appropriately from those of

Inside debt, such as pensions and deferred compensation, constitutes a widely-used form of executive compensation, yet the the valuation and incentive effects of these instruments have been almost entirely overlooked by prior work. Our paper initiates this line of research. Among our findings are that pensions constitute a significant component of overall compensation; that CEO compensation in most firms exhibits a balance between debtand equity-based incentives, with the balance shifting systematically away from equity and toward debt as CEOs grow older; that CEOs with high debt-based incentives manage their firms conservatively to reduce default risk; and that pension plan compensation strongly influences patterns of CEO turnover and CEO cash compensation.

as Viral Acharya and Christopher Mann for their insightful comments. This paper would not have seen the light of day (at least not under its actual form) without the constant help and support from Kenneth Garbade. A special thought goes to Claudia Perlich and Jerold Weiss. The usual disclaimer applies. Temporal Resolution of Uncertainty, the Investment Policy of Leveraged Firms and Corporate Debt Yields This paper attempts to link the agency literature (concerned with whether debt will trigger underinvestment incentives or risk-shifting behavior) with the one dealing with temporal resolution of uncertainty. To the best of our knowledge, apart from one article by John and Ronen (1990), there is no research article linking the two literatures. We are concerned here with how the product/input market influences deviations from the optimal investment policy, in particular to what extent the speed of resolution of uncertainty of the industry in which a given firm operates affects the risk-shifting behavior of a shareholder-aligned manager. We assume that investors are risk neutral and that the return on the risky technology is normally distributed. It is then shown that the pattern of temporal resolution of uncertainty monotonically affects risk shifting as well as bond yields, even after contracts mitigating deviations from optimal investment policy have been written; empirical implications are derived and discussed. 2

in the Banking Industry In this paper, we study how the pay-performance sensitivity in an optimally-designed, top management compensation structure in banks is affected by the characteristics of alternative mechanisms of corporate governance. Given the bank’s claim structure, the subordinated debtholders and the regulator have the incentives to monitor the bank. We analyze theoretically whether the intensity of these monitoring mechanisms would play a complementary or substitute role to the strength of incentive features in top management compensation. Although the payperformance sensitivity of bank CEO compensation decreases with the total leverage ratio, we show that the monitoring provided by either subordinated debtholders or regulators allow the bank to increase the pay-performance sensitivity in the optimal CEO compensation. Consistent with the theoretical predictions, we find empirical evidence that the pay-performance sensitivity decreases with banks ’ total leverage, but increases with its subordinated debt ratio and the intensity of regulatory monitoring, which is proxied by a poorer examination rating (BOPEC). 1 1.