Abstract
We present a rational expectations model of optimal executive compensation in a setting where managers are in a position to manipulate short-term stock prices, and managers?propensity to manipulate is uncertain. We analyze the tradeo¤s involved in conditioning pay on long- versus short-term performance and show how manipulation, and investors?uncertainty about it, a¤ects the equilibrium pay contract and the informativeness of asset prices. Characteristics of firms and managers determine the optimal compensation scheme: the strength of incentives, the pay horizon and the use of options. We consider the role of corporate governance regulations and disclosure policies in enabling better contracts.