CEO Contract Design: How Do Strong Principals Do It?

We study changes in the design of CEO contracts when firms transition from being public with dispersedshareholders to having strong principals in the form of private equity sponsors. These principals redesignsome, but far from all, contract characteristics. There is no evidence that they reduce salary, bonus, andperquisites, but they redesign contracts away from earnings-based and non-financial bonus criteria. Theydo not change CEO severance cash pay, but they redesign contracts so unvested equity is forfeited byterminated CEOs, and they restrict the resale market for equity. CEO contracts are also redesigned so thata significant fraction of equity grants performance-vest: if the agent does not produce prespecifiedmultiples or IRRs, the equity is forfeited. We find that even these sophisticated principals rely onsubjective performance evaluation, use some time-vesting equity, do not use premium options, and do notcondition vesting on relative performance. We compare the real-world contracts in our sample tocontracting theories, and we relate our findings to recent discussions of executive compensation reform.[...]