Research and publications

On the Valuation and Incentive Effects of Executive Cash Bonus Contracts

Executive compensation packages are often valued in an inconsistent manner: while employee stock options (ESOs) are typically valued ex-ante, i.e., before uncertainties are resolved, cash bonuses are valued ex-post, i.e., by discounting the realized cash grants. Such a lack of consistency can, potentially, distort empirical results. A related, yet mostly overlooked, problem is that when ex-post valuation is used pay-performance measures can not be well defined. Consistent use of ex-ante valuation for all components of a compensation package would simultaneously resolve both of these problems and provide a natural framework for the analysis of agency problems.

Author(s):

Lionel Martellini, Branko Urosevic

Summary:

Executive compensation packages are often valued in an inconsistent manner: while employee stock options (ESOs) are typically valued ex-ante, i.e., before uncertainties are resolved, cash bonuses are valued ex-post, i.e., by discounting the realized cash grants. Such a lack of consistency can, potentially, distort empirical results. A related, yet mostly overlooked, problem is that when ex-post valuation is used pay-performance measures can not be well defined. Consistent use of ex-ante valuation for all components of a compensation package would simultaneously resolve both of these problems and provide a natural framework for the analysis of agency problems.

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Type :	Working paper
Date :	05/01/2003
Keywords :	Performance

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