DP7442 Managerial Incentives and Stock Price Manipulation

Author(s): Lin Peng, Ailsa A Röell
Publication Date: September 2009
Keyword(s): corporate governance, Executive compensation, long- versus short-term, manipulation uncertainty
JEL(s): D8, G30, G34, J33, J41, K2
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=7442

This paper presents a rational expectations model of optimal executive compensation in a setting where managers are in a position to manipulate short-term stock prices, and managers' propensity to manipulate is uncertain. Stock-based incentives elicit not only productive effort, but also costly information manipulation. We analyze the tradeoffs involved in conditioning pay on long- versus short-term performance and characterize a second-best optimal compensation scheme. The paper shows manipulation, and investors' uncertainty about it, affects the equilibrium pay contract and the informational efficiency of asset prices. The paper derives a range of new cross-sectional comparative static results and sheds light on corporate governance regulations.