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Working Paper

Executive Compensation: A Calibration Approach

We use a version of the Grossman and Hart (1983) principal-agent model with 10 actions and 10 states to produce quantitative predictions for executive compensation. Performance incentives derived from the model are compared with the performance incentives of 350 firms from a survey by Michael Jensen and Kevin Murphy. The results suggest both that the model does a reasonable job of explaining the data and that actual incentives are close to the optimal incentives predicted by theory.

Working Papers of the Federal Reserve Bank of Cleveland are preliminary materials circulated to stimulate discussion and critical comment on research in progress. They may not have been subject to the formal editorial review accorded official Federal Reserve Bank of Cleveland publications. The views expressed in this paper are those of the authors and do not represent the views of the Federal Reserve Bank of Cleveland or the Federal Reserve System.

Suggested Citation

Haubrich, Joseph G., and Ivilina Popova. 1994. “Executive Compensation: A Calibration Approach.” Federal Reserve Bank of Cleveland, Working Paper No. 94-16.