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Internal versus external CEO choice and the structure of compensation contracts

Published online by Cambridge University Press:  28 August 2013

Frédéric Palomino  and
Eloïc Peyrache
Frédéric Palomino
Affiliation:
frederic.palomino@edhec.edu, EDHEC Business School, Department of Economics, 18 rue du 4 Septembre, Paris 75002, France
Eloïc Peyrache
Affiliation:
peyrache@hec.fr, HEC Paris, Finance and Economics Department, 1, rue de la Libération, Jouy en Josas 78351 Cedex, France.
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Abstract

Any firm choosing a chief executive officer (CEO) faces a double problem: candidate selection and choice of a compensation scheme. We derive sufficient conditions where the unique optimal compensation scheme is a capped-bonus contract in a pure moral-hazard environment, while equity is used when the firm also faces adverse selection. Then, we provide a rationale for the simultaneous increases in CEO pay, use of equity in compensation, and external hiring of CEOs. Our results are consistent with empirical evidence that shows externally hired CEOs earn more than those internally hired and that externally hired CEOs get a higher fraction of their compensation equity based.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 48 , Issue 4 , August 2013 , pp. 1301 - 1331
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2013 

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