Internal vs external CEO choice and the structure of compensation contracts

Palomino, Frédéric; Peyrache, Eloïc
August 2013
Journal of Financial & Quantitative Analysis;2013, Vol. 48 Issue 4, p1301
Academic Journal
Any firm choosing a 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.


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