The Effects of Short-Selling Threats on Incentive Contracts : Evidence from an Experiment

This paper examines the effects of a shock to the stock-price formation process on the design of executive incentive contracts. We find that an exogenous removal of short-selling constraints causes firms to convexify compensation payoffs by granting relatively more stock options to their managers. We also find that treated firms adopt new anti-takeover provisions. These results suggest that when firms face the threat of bear raids, they incentivize managers to take actions that mitigate the adverse effects of unrestrained short selling. Overall, this paper provides causal evidence that financial markets affect incentive contract design