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Performance Periods in CEO Performance-Based Equity Awards: Theory and Evidence

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Abstract

This paper examines the length of time over which CEO performance is evaluated (the "performance period") in CEO performance-based equity awards (PBEAs). Departing from the primary emphasis of agency theory on moral hazard problems, we develop a model in which short performance periods are instrumental in sorting CEO talents. The model predicts that short performance periods are preferred when CEOs have low expected productivity or valuable alternative employment opportunities, and when firms face high operating uncertainty or high dispersion of managerial productivity. We find empirical support for these predictions in a sample of S&P 1500 industrial firms granting PBEAs to CEOs. We also document that CEO turnover is higher for underperforming CEOs with shorter performance periods, validating the sorting role of performance periods.

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[Evans, John Harry] University of Pittsburgh

[Gao, Zhan] Lancaster University

[Hwang, Yuhchang] China Europe International Business School

[Wu, Wan-Ting] University of Massachusetts Boston


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Source

The Accounting Review

ISSN:0001-4826

Year:2018

Issue:2

Volume:93

Page:161-190

ESI Discipline:ECONOMICS & BUSINESS;

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