This paper analyzes optimal executive compensation contracts when managers are loss averse. We calibrate a stylized principal-agent model to the observed contracts of 595 CEOs and show that this model can explain observed option holdings and high base salaries remarkably well for a range of parametrizations. We also derive and calibrate the general shape of the optimal contract that is increasing and convex for medium and high outcomes and drops discontinuously to the lowest possible payout for low outcomes. We identify the critical features of the loss-aversion model that render optimal contracts convex.

Additional Metadata
Keywords CEOs, compensation contracts, loss aversion
Persistent URL dx.doi.org/10.1111/j.1540-6261.2010.01609.x, hdl.handle.net/1765/20740
Citation
Dittmann, I, Maagdenberg, A.M.J.M, & Spalt, O.G. (2010). Sticks or Carrots? Optimal CEO Compensation when Managers are Loss Averse. The Journal of Finance, 65(6), 2015–2050. doi:10.1111/j.1540-6261.2010.01609.x