Incentives for CEOs to Exit

Abstract

An important question for firms in dynamic industries is how to induce a CEO to reveal information that the firm should change its strategy, in particular when a strategy change might cause his own dismissal. We show that the uniquely optimal incentive scheme from this perspective consists of options, a base wage, and severance pay. Option compensation minimizes the CEO’s expected on-the-job pay from continuing with a poor strategy. Hence, a smaller severance payment is needed to induce the CEO to reveal information causing a strategy change than, e.g., under stock compensation or other forms of variable pay. The model suggests how deregulation and massive technological changes in the 1980s and 1990s may have contributed to the dramatic rise in CEO pay and turnover over the same period.