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1、THEJOURNALOFFINANCE•VOL.LXVII,NO.5•OCTOBER2012DynamicCEOCompensationALEXEDMANS,XAVIERGABAIX,TOMASZSADZIK,andYULIYSANNIKOV∗ABSTRACTWestudyoptimalcompensationinadynamicframeworkwheretheCEOconsumesinmultipleperiods,canundothecontractbyprivatelysaving,andcantemporarilyinflateearn
2、ings.Weobtainasimpleclosed-formcontractthatyieldsclearpredic-tionsforhowthelevelandperformancesensitivityofpayvaryovertimeandacrossfirms.ThecontractcanbeimplementedbyescrowingtheCEO’spayintoa“DynamicIncentiveAccount”thatcomprisescashandthefirm’sequity.Theaccountfeaturesstate-d
3、ependentrebalancingtoensureitsequityproportionisalwayssufficienttoinduceeffort,andtime-dependentvestingtodetershort-termism.MANYCLASSICALMODELSOFCEOcompensationconsideronlyasingleperiod,ormultipleperiodswithasingleterminalconsumption.However,theoptimalstaticcontractmaybeineff
4、ectiveinadynamicworld.Inreality,securitiesgiventoincentivizetheCEOmaylosetheirpowerovertime:iffirmvaluedeclines,optionsmayfalloutofthemoneyandbearlittlesensitivitytothestockprice.TheCEOmaybeabletoengageinprivatesavingtoachieveahigherfutureincomethanintendedbythecontract,intur
5、nreducinghisef-fortincentives.Single-periodcontractscanencouragetheCEOtoengageinshort-termism/myopia,thatis,inflatethecurrentstockpriceattheexpenseoflong-runvalue.Inadditiontotheabovechallenges,adynamicsettingpro-videsopportunitiestothefirm—itcanrewardeffortwithfuturerathertha
6、ncurrentpay.Thispaperanalyzesadynamicmodelthatallowsforalloftheabovecom-plications,whicharelikelyimportantfeaturesinreality.Wetakeanoptimalcontractingapproachthatallowsforfullyhistory-dependentcontractswithout∗EdmansisfromTheWhartonSchool,UniversityofPennsylvania,NBER,andECG
7、I;GabaixisfromtheNYUSternSchoolofBusiness,NBER,CEPR,andECGI;SadzikisfromNewYorkUniversity;andSannikovisfromPrincetonUniversity.Forhelpfulcomments,wethankananony-mousreferee,anAssociateEditor,theEditor(CamHarvey),RajAggarwal,GaryBecker,GillesChemla,IngolfDittmann,PhilDybvig,O
8、liverHart,KenFeinberg,MikeFishman,ChristianGould-ing,ZhiguoHe,MarcusOpp,Tom
