Optimal Compensation Contracts with Pay-For-Performance and Termination Incentives
December 1999
Greg Hallman, Jay C. Hartzell
ABSTRACT
This paper studies optimal compensation contracts in the presence of both pay-for-performance and termination incentives.
While these incentives have been studied independently, this paper’s model is the first to incorporate both. The
primary result is
that pay-for-performance and the threat of termination are substitute incentive devices; holding effort constant,
optimal pay-for-performance incentives are increasing in the cost of termination. Our test of this result compares
compensation contracts of managers of real estate investment trusts and general partners of real estate limited
partnerships. REIT managers’ wealth changes by $25.30 per $1,000 change in REIT value. Compensation for general
partners, who are more costly to fire than REIT managers, changes by $253.57 per $1,000 change in partnership value.
Hartzell: (212) 995-4233 jhartzel@stern.nyu.edu
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