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Finance Department's Lecture

TIME: 15:00 ,Jul9,2018
PLACE:Room 1007, Business Building

TOPIC:Labor Market Immobility and Incentive Contract Design 

This paper studies the effects of heightened labor market immobility on executive incentive contract design. We exploit the staggered adoption of the Inevitable Disclosure Doctrine (IDD) by U.S. state courts as an exogenous negative shock to top executives’ labor market mobility. Using a difference-in-difference approach, we find that adoption of the IDD causes a firm to increase the convexity of option holdings by its managers. We also find that for new option grants made after adoption of the IDD, treated firms are more likely to use progressive performance vesting—a vesting condition that helps remove options that have lost risk-taking incentives after becoming deep in-the-money. We also find that adoption of the IDD leads to new option grants with long-term vesting schedules. Our results are consistent with reduced managers’ incentives to choosing risky but valuable long-term investment when they expect increased labor market mobility hurdles. In response, firms adjust compensation-based incentives in an optimal contracting manner. Overall, this study provides causal evidence that labor markets affect incentive contract design.