CEO Replacement Under Private Information

This article examines the optimal CEO compensation and replacement policy when the CEO is privately informed about the firm's continuation value under his leadership. Ex ante moral hazard implies that the CEO must receive ex post quasi rents, which endogenously biases him toward continuation. O...

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Bibliographic Details
Published in:The Review of financial studies 2010-08, Vol.23 (8), p.2935-2969
Main Authors: Inderst, Roman, Mueller, Holger M.
Format: Article
Language:English
Subjects:
Business risks
Business structures
Chief executive officers
Corporate governance
Earnings
Empirical research
Executive compensation
Golden handshake
Incentive pay
Information
Leadership
Moral hazard
Performance metrics
Quasi rent
Risk
Severance pay
State of nature
Studies
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Summary:This article examines the optimal CEO compensation and replacement policy when the CEO is privately informed about the firm's continuation value under his leadership. Ex ante moral hazard implies that the CEO must receive ex post quasi rents, which endogenously biases him toward continuation. Our model shows that to induce "bad" CEOs to quit, it may be best to make continuation costly (through steep incentive pay) rather than simply rewarding quitting (through severance pay). Incentive pay makes continuation attractive for "good" CEOs, who can expect high future on-the-job pay, but unattractive for "bad" CEOs, who may instead prefer to take their outside option payoff. Our model generates novel empirical implications that jointly relate CEO compensation and turnover to corporate governance, firm size, cash-flow risk, and the informativeness of performance measurement.
ISSN:0893-9454
1465-7368
DOI:10.1093/rfs/hhq018