How Much to Pay in Cash? Employee Retention via Stock Option

We model deferred compensation as a share of an uncertain futureprofit granted by a financially constrained employer to her employeein mutual agreement. Deferred compensation serves as a retentionmechanism, helping the employer to avoid bankruptcy. The optimalcombination of cash and deferred payments that a firm can use to re-tain qualified personnel depends on the cost of new credit and bank-ruptcy risk: If interest rates are greater (smaller) than the ex-anteodds of bankruptcy, the employer will to defer compensation (pay incash) to the employee. The employee always improves his position inthe labor market if imminent bankruptcy is avoided.