Compensation Contract Design to Mitigate Adverse Selection: Inducement Grants and New CEO Announcements

Abstract We examine how firms design compensation contracts to mitigate adverse selection problems when hiring a new CEO. Focusing on the sensitivity of inducement grants to the new CEO announcement return, we predict and find that firms provide inducement grants that are more sensitive to the new CEO announcement return when costs of adverse selection problems are higher and information asymmetry about the new CEO is more severe. Consistent with inducement grant sensitivity mitigating adverse selection problems, we find that the market reacts more favorably to new CEO announcements with inducement grants that are more sensitive to the announcement return.