Selecting optimal executive compensation scheme under uncertainty and the role of the covariance factors

Outlines previous research on compensation schemes in situations of uncertainty and explores the effects of three different plans on managers’ output decisions. Discusses the role of flat salary, profit share, actual shares and share options in increasing goal congruity between the manager and the company, develops a mathematical model and applies it to three compensation schemes. Presents the results, which suggest that a basic profit sharing structure is best when the covariance factor between product price and firm valuation is negative; and the inclusion of stock options is best when the factor is positive.