Fair and Square: A Retention Model of Managerial Compensation

We propose a model of how the retention motive shapes managerial compensation contracts. Once employed, a risk-averse manager acquires imperfectly portable skills whose value is stochastic because of industry-wide demand shocks. The manager’s actions are uncontractible, and the perceived fairness of the compensation contract affects the manager’s motivation. If the volatility of profits is sufficiently large and outside offers are sufficiently...