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We calibrate the standard principal–agent model with constant relative risk aversion and lognormal stock prices to a sample of 598 U.S. CEOs. We show that this model pre-dicts that most CEOs should not hold any stock options. Instead, CEOs should have lower base salaries and receive additional shares in their companies; many would be required to purchase additional stock in their companies. These contracts would re-duce average compensation costs by 20 % while providing the same incentives and the same utility to CEOs. We conclude that the standard principal–agent model typically used in the literature cannot rationalize observed contracts. We don’t give options because it would be a lottery ticket. (Warren Buffet) There will be no new stock option grants from Microsoft. Instead, we will award actual stock to our employees. (Steve Ballmer, Microsoft) THIS PAPER ANALYZES THE OPTIMAL STRUCTURE OF CEO PAY, or, more specifically, the

Abstract Using a comprehensive database of hedge funds, we examine the role of managerial incentives and discretion in the performance of hedge funds. We find that hedge funds with greater managerial incentives as proxied by delta of option-like incentive fee contract, managerial ownership, and high-water mark provision are associated with superior performance. Incentive fees have no explanatory power for future returns. We also find that funds with higher degree of managerial discretion, proxied by longer lockup, notice, and redemption periods, are associated with superior performance. Our results are robust to various alternate specifications including using alternative performance measures, allowing for nonlinearity for managerial discretion, using different econometric specifications, and controlling for different data-related biases. , and MSCI for providing us with the data on hedge funds. We are thankful to Burak Ciceksever, Otgontsetseg Erhemjamts, and Purnendu Nath for excellent research assistance. We are responsible for all errors. ____________________________________________ Role of managerial incentives and discretion in hedge fund performance Abstract Using a comprehensive database of hedge funds, we examine the role of managerial incentives and discretion in the performance of hedge funds. We find that hedge funds with greater managerial incentives as proxied by delta of option-like incentive fee contract, managerial ownership, and high-water mark provision are associated with superior performance. Incentive fees have no explanatory power for future returns. We also find that funds with higher degree of managerial discretion, proxied by longer lockup, notice, and redemption periods, are associated with superior performance. Our results are robust to various alternate specifications including using alternative performance measures, allowing for nonlinearity for managerial discretion, using different econometric specifications, and controlling for different data-related biases.

We model CEO and director compensation using firm characteristics, CEO characteristics, and governance variables. After controlling for monitoring proxies, we find a significant positive relationship between CEO and director compensation. We hypothesize that this relationship could be due to unobserved firm complexity (omitted variables), and/or to excess compensation of directors and managers. We also find evidence that excess compensation (both director and CEO) is associated with firm underperformance. We therefore conclude that the evidence is consistent with excessive compensation due to mutual back scratching or cronyism. The evidence suggests that excessive compensation has an effect on firm performance that is independent of the poor governance variables discussed by previous studies.

This study investigates the association between the structure of executive compensation and accounting fraud. We study 50 firms accused of accounting fraud by the Securities and Exchange Commission (SEC) during the period 1996-2003 as compared to firms not accused of accounting fraud during the same period. We find that the probability of accounting fraud is increasing in the percent of total executive compensation that is stock-based (termed stock-based mix) after controlling for governance characteristics, financial performance, financial distress, firm size, and the likelihood of management wanting to obtain external financing. We find that while the unconditional likelihood of accounting fraud is small, a one standard deviation increase in the proportion of compensation that is stock-based increases the probability of an accounting fraud by approximately 68%. For managers to undertake fraud they must perceive positive benefits from it. We examine the extent to which managerial wealth was overstated prior to the alleged fraud by measuring the decline in managerial wealth once the alleged fraud was made public. We find

2003 meetings in Glasgow. We are grateful for funding

This paper can be downloaded without charge from: The Harvard John M. Olin Discussion Paper Series:

Corporate Governance and Equilar Inc. for providing a portion of the data used in this paper,

This paper, which serves as an introduction to the special issue on corporate governance of the Review of Financial Studies, reviews and comments on the state of corporate governance research. The special issue features seven papers on corporate governance that were presented in a meeting of the National Bureau of Economic Research’s (NBER’s) corporate governance project. Each of the papers represents state-of-the-art research in an important area of corporate governance research. For each of these areas, we discuss the importance of the area and the questions it focuses on, how the paper in the special issue makes a significant contribution to this area, and what we do and do not know about the area. We discuss in turn work on shareholders and shareholder activism, directors, executives and their compensation, controlling shareholders, comparative corporate governance, cross-border investments in global capital markets, and the political economy of corporate governance.

paper represents a major extension of a section in Chapter 2 of my Ph.D. dissertation submitted to the University of California at Berkeley, where a two-asset equilibrium was developed. I am very grateful to Navneet Arora