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Journal of Finance Vol. 65 No. 6 2010

Sticks or Carrots? Optimal CEO Compensation when Managers Are Loss Averse

Ingolf Dittmann1; Ernst Maug2; Oliver G. Spalt2,3

1 Erasmus University Rotterdam · 2 University of Mannheim · 3 European Respiratory Society

open access

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.

DOI
10.1111/j.1540-6261.2010.01609.x
Volume
65
Issue
6
Pages
2015-2050
Language
en
Sources
bibtex:phds-export.bib openalex crossref

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