Journal Article

Executive Compensation and Short-Termist Behaviour in Speculative Markets

Patrick Bolton, José Scheinkman and Wei Xiong

in The Review of Economic Studies

Published on behalf of Review of Economic Studies Ltd

Volume 73, issue 3, pages 577-610
Published in print July 2006 | ISSN: 0034-6527
Published online July 2006 | e-ISSN: 1467-937X | DOI: http://dx.doi.org/10.1111/j.1467-937X.2006.00388.x
Executive Compensation and Short-Termist Behaviour in Speculative Markets

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We present a multiperiod agency model of stock-based executive compensation in a speculative stock market, where investors have heterogeneous beliefs and stock prices may deviate from underlying fundamentals and include a speculative option component. This component arises from the option to sell the stock in the future to potentially overoptimistic investors. We show that optimal compensation contracts may emphasize short-term stock performance, at the expense of long-run fundamental value, as an incentive to induce managers to pursue actions which increase the speculative component in the stock price. Our model provides a different perspective on the recent corporate crisis than the “rent extraction view” of executive compensation.

Keywords: M12; M52

Journal Article.  14840 words.  Illustrated.

Subjects: Wages, Compensation, and Labour Costs ; Human Resource Management

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