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Working Papers

September 2014, No. 14-16

The Complexity of CEO Compensation

Arantxa Jarque

I study firm characteristics that justify the use of options or refresher grants in the optimal compensation packages for CEOs in the presence of moral hazard. I model explicitly the determination of stock prices as a function of the output realizations of the firm: Symmetric learning by all parties about the exogenous quality of the firm makes stock prices sensitive to output observations. Compensation packages are designed to transform this sensitivity of prices-to-output into the sensitivity of consumption-to-output that is dictated by the optimal contract. Heterogeneity in the structure of firm uncertainty implies that some firms are able to implement the optimal contract with very simple schemes that do not include options, refresher grants, or perks, while others need to use these more complex and potentially less transparent instruments.