TITLE

Form of Compensation and Managerial Decision Horizon

AUTHOR(S)
Narayanan, M. P.
PUB. DATE
December 1996
SOURCE
Journal of Financial & Quantitative Analysis;Dec96, Vol. 31 Issue 4, p467
SOURCE TYPE
Academic Journal
DOC. TYPE
Article
ABSTRACT
This paper investigates the relation between the form of compensation and the manager's decision horizon. It finds that while all-cash contracts induce managers to underinvest in the long term, all-stock contracts induce overinvestment in the long term. It shows that compensation contracts consisting of both cash and restricted stock can produce efficient investment, thereby providing a rationale for the existence of both cash and stock incentive schemes in executive compensation packages. This explains why the adoption of either type of incentive scheme results in a positive stock price reaction. In addition, the paper derives the following testable hypotheses: i) the proportion of the stock compensation is decreasing in the precision of the manager's ability and increasing in the precision of the firm's cash flows; ii) firms compensate their managers with proportionately more stock in profitable years and proportionately more cash in leaner years; and iii) the greater the growth opportunities, the higher the proportion of stock compensation.
ACCESSION #
9706091240

 

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