Options in Compensation

Promises and Pitfalls

Christian Riis Flor, Hans Frimor, Claus Munk

Research output: Contribution to journalJournal articleResearchpeer-review

Abstract

We derive the optimal compensation contract in a principal–agent setting in which outcome is used to provide incentives for both effort and risky investments. To motivate investment, optimal compensation entails rewards for high as well as low outcomes, and it is increasing at the mean outcome to motivate effort. If rewarding low outcomes is infeasible, compensation consisting of stocks and options is a near-efficient means of overcoming the manager's induced aversion to undertaking risky investments, whereas stock compensation is not. However, stock plus option compensation may induce excessively risky investments, and capping pay can be important in curbing such behavior.
Original languageEnglish
JournalJournal of Accounting Research
Volume52
Issue number3
Pages (from-to)703-732
ISSN0021-8456
DOIs
Publication statusPublished - 2014

Cite this

Flor, Christian Riis ; Frimor, Hans ; Munk, Claus. / Options in Compensation : Promises and Pitfalls. In: Journal of Accounting Research. 2014 ; Vol. 52, No. 3. pp. 703-732.
@article{0e7fc666c08746a5966e39c3714ea58e,
title = "Options in Compensation: Promises and Pitfalls",
abstract = "We derive the optimal compensation contract in a principal–agent setting in which outcome is used to provide incentives for both effort and risky investments. To motivate investment, optimal compensation entails rewards for high as well as low outcomes, and it is increasing at the mean outcome to motivate effort. If rewarding low outcomes is infeasible, compensation consisting of stocks and options is a near-efficient means of overcoming the manager's induced aversion to undertaking risky investments, whereas stock compensation is not. However, stock plus option compensation may induce excessively risky investments, and capping pay can be important in curbing such behavior.",
keywords = "Compensation management, Agency Theory, Investment risk, Stock options, Wages - Government policy, Corporate governance, Global Financial Crisis, 2008-2009, Motivation (Psychology)",
author = "Flor, {Christian Riis} and Hans Frimor and Claus Munk",
year = "2014",
doi = "10.1111/1475-679X.12049",
language = "English",
volume = "52",
pages = "703--732",
journal = "Journal of Accounting Research",
issn = "0021-8456",
publisher = "Wiley-Blackwell",
number = "3",

}

Options in Compensation : Promises and Pitfalls. / Flor, Christian Riis; Frimor, Hans; Munk, Claus.

In: Journal of Accounting Research, Vol. 52, No. 3, 2014, p. 703-732.

Research output: Contribution to journalJournal articleResearchpeer-review

TY - JOUR

T1 - Options in Compensation

T2 - Promises and Pitfalls

AU - Flor, Christian Riis

AU - Frimor, Hans

AU - Munk, Claus

PY - 2014

Y1 - 2014

N2 - We derive the optimal compensation contract in a principal–agent setting in which outcome is used to provide incentives for both effort and risky investments. To motivate investment, optimal compensation entails rewards for high as well as low outcomes, and it is increasing at the mean outcome to motivate effort. If rewarding low outcomes is infeasible, compensation consisting of stocks and options is a near-efficient means of overcoming the manager's induced aversion to undertaking risky investments, whereas stock compensation is not. However, stock plus option compensation may induce excessively risky investments, and capping pay can be important in curbing such behavior.

AB - We derive the optimal compensation contract in a principal–agent setting in which outcome is used to provide incentives for both effort and risky investments. To motivate investment, optimal compensation entails rewards for high as well as low outcomes, and it is increasing at the mean outcome to motivate effort. If rewarding low outcomes is infeasible, compensation consisting of stocks and options is a near-efficient means of overcoming the manager's induced aversion to undertaking risky investments, whereas stock compensation is not. However, stock plus option compensation may induce excessively risky investments, and capping pay can be important in curbing such behavior.

KW - Compensation management

KW - Agency Theory

KW - Investment risk

KW - Stock options

KW - Wages - Government policy

KW - Corporate governance

KW - Global Financial Crisis, 2008-2009

KW - Motivation (Psychology)

U2 - 10.1111/1475-679X.12049

DO - 10.1111/1475-679X.12049

M3 - Journal article

VL - 52

SP - 703

EP - 732

JO - Journal of Accounting Research

JF - Journal of Accounting Research

SN - 0021-8456

IS - 3

ER -