NEW YORK--(BUSINESS WIRE)--Having regulated CEO pay in firms that have received bailout money, the Obama administration is now in serious discussions about overhauling compensation practices across the entire financial services industry. A working paper by Alex Edmans, Assistant Professor of Finance at the Wharton School of the University of Pennsylvania, and Xavier Gabaix, Associate Professor of Finance at NYU Stern, coauthored with Tomasz Sadzik of NYU and Yuliy Sannikov of Princeton, proposes a solution to executive compensation that will address a number of problems that led to the current crisis. The paper is titled “Dynamic Incentive Accounts” and is publicly available at http://ssrn.com/abstract=1361797.
There are two main problems with existing schemes: they are typically short-term focused and they fail to keep pace with a firm’s changing conditions. For example, if a firm’s stock plummets, options are close to worthless and have little incentive effect.
The authors’ proposed solution aims to solve both of these issues. Their proposal involves creating “dynamic incentive accounts” to ensure that top management has a stake in the long-term success of the firm at all times. “Dynamic incentive accounts” would:
Since the manager is “reloaded” with new shares after the stock falls, his incentives remain strong. Importantly, unlike the current practice of repricing options that have become worthless, this reloading is not for free – the additional shares are paid for by reducing the cash in the account. The authors explain: “Compensation schemes should tie a manager to long-term performance, and provide strong incentives to improve shareholder value in both good and bad times.”
To arrange an interview with Professor Gabaix, contact firstname.lastname@example.org or contact Rika Nazem, NYU Stern’s Office of Public Affairs, email@example.com, 212-998-0678. To arrange an interview with Professor Edmans, contact firstname.lastname@example.org or contact Phyllis Stevenson, Wharton Communications Office, email@example.com, 215-573-7636.