a multiplicative model of optimal ceo incentives in market equilibrium this paper presents a unified theory of both the level and sensitivity of pay in competitive market equilibrium by embedding a moral hazard problem into a talent assignment model by considering multiplicative specifications for the ceo s utility and production functions we generate a number of different results from traditional additive models first both the ceo s low fractional ownership the jensen murphy incentives measure and its negative relationship with firm size can be quantitatively reconciled with optimal contracting and thus need not reflect rent extraction second the dollar change in wealth for a percentage change in firm value divided by annual pay is independent of firm size and therefore a desirable empirical measure of incentives third incentive pay is effective at solving agency problems with multiplicative impacts on firm value such as strategy choice however additive issues such as perk consumption are best addressed through direct monitoring jel d2 d3 g34 j3

optimal income taxation with adverse selection in the labour market this article studies optimal linear and non linear redistributive income taxation when there is adverse selection in the labour market unlike in standard taxation models firms do not know workers abilities and competitively screen them through non linear compensation contracts unobservable to the government in a miyazaki wilson spence equilibrium adverse selection leads to different optimal tax formulas than in the standard mirrlees 1971 model because of the use of work hours as a screening tool by firms which for higher talent workers results in a rat race and for lower talent workers in informational rents and cross subsidies the most surprising result is that if the government has sufficiently strong redistributive goals welfare is higher when there is adverse selection than when there is not policies that endogenously affect adverse selection are discussed the model has practical implications for the interpretation estimation and use of taxable income elasticities which are central to optimal tax design

planning under incomplete information and the ratchet effect abstract central planning of production is usually performed under asymmetric information the firm in general has more information about its productive possibilities than the central planner from now on for short cp this justifies the use of incentives schemes in which the cp does not directly fix activity levels casual observation of such existing schemes suggests that the time dimensions is crucial for their working typically the cp revises the incentive scheme over time to take into account the information provided by the firm s performance managers of centrally planned economies as well as economists have long recognized that this revision induces firms to underproduce in order to avoid demanding schemes in the future this is the ratchet effect it is purpose of the present paper to study the ratchet effect under the non commitment assumption which we believe to be more realistic the inadequacy of conceptual tools made if difficult in the past to consider such an assumption now basic research on dynamic games with incomplete information recently resulted in new ideas which look particularly relevant for a theoretical analysis of the problem

commitment and fairness in a dynamic regulatory relationship this paper considers a multiperiod model of a regulated firm that has stationary private information which may be revealed through performance if it cannot make commitments to future policies the regulator has an incentive to exploit any information the firm reveals and laffont and tirole show that there is no regulatory policy that is separating over any closed interval a fairness arrangement is proposed in which the firm agrees not to quit if in future periods the regulator allows it to earn a nonnegative profit given the type it revealed in earlier periods the properties of such arrangements are studied and an example is presented in which both the firm and the regulator prefer a fairness arrangement to a policy feasible without commitment

reputation and hierarchy in dynamic models of employment the employment relationship with employees ability and their actions both private information thus combining adverse selection with moral hazard is modeled as a repeated game with self enforcing contracts being perfect bayesian nash equilibria under termination contracts the equilibrium contract structure consists of a hierarchy of ranks finite in number even though ability is continuous reputation acts as an effective device for worker discipline without the need for involuntary unemployment selection by bonding is not in general incentive compatible but selection by promotion of employees through the ranks is many other features correspond to observed employment structures

an empirical examination of the relation between debt contracts and management incentives abstract prior research on the factors influencing the use of debt covenants restricting dividends and additional borrowing is extended by considering management incentives when alternative incentive variables are considered separately we find covenants have a significant negative relation to ceo cash compensation an insignificant relation to the value of ceo equity held and significant positive relations to both the ratio of the value of ceo equity holdings to cash compensation and the fraction of equity held by the ceo in two stage simultaneous equations models only the latter is significant when jointly considered with each of the other incentive variables

dynamic contracts with worker mobility via directed on the job search this article proposes a model with dynamic incentive contracts and on the job search in a frictional labor market the optimal long term contract exhibits an increasing wage tenure profile with increasing wages worker effort also increases with tenure these two features imply that the probabilities of both voluntary and involuntary job separation decrease with both job tenure and the duration of employment given these results workers experience differing labor market transitions between employment unemployment and across different employers and the equilibrium generates endogenous heterogeneity among ex ante homogeneous workers abstract from author

bonuses and promotion tournaments theory and evidence standard models of promotion tournaments do not distinguish between wages and bonuses and thus cannot explain variation in the use of bonuses we combine classic and market based tournament theories to develop a model in which wages and bonuses serve distinctly different roles we use this model to derive testable predictions which we test employing both a single firm data set and a data set encompassing a large segment of the finnish economy our empirical analysis supports the testable predictions and shows that our theoretical approach better matches the data than alternative theories of bonus determination based on arguments already in the literature

incentives learning and compensation a theoretical and empirical investigation of managerial labor contracts this article analyzes properties and implications of multiperiod managerial labor contracts under two alternative hypotheses incentives in which productivity depends on unobservable effort and learning in which ability is unknown and is revealed over time shared and conflicting implications of these competing models are developed in terms of experienceearnings profiles and the relation between compensation and performance i empirically examine these theoretical results by using a longitudinal sample of 1 488 chief executive officers followed from 1974 1985 the data yield mixed evidence that generally supports the learning hypothesis over the incentive hypothesis

political promotion ceo incentives and the relationship between pay and performance both theory and empirical evidence suggest that managers career concerns can serve as an important source of implicit economic incentives we examine how incentives for political promotion are related to compensation policy and firm performance in chinese state owned enterprises we find that the likelihood that the ceo receives a political promotion is positively related to firm performance we also find that ceos with a higher likelihood of political promotion have lower pay levels and lower pay performance sensitivity overall the evidence suggests that competition in the political job market helps mitigate weak monetary incentives for ceos in china data are available at https doi org 10 1287 mnsc 2017 2966 this paper was accepted by lauren cohen finance

lending to small businesses the role of loan maturity in addressing information problems we investigate what determines the maturity of lines of credit to small businesses our results provide strong support for the hypothesis that shorter loan maturities serve to mitigate the problems associated with borrower risk and asymmetric information that are typical of small business lending we find that maturity is shorter for firm owners that have poor credit histories are older and less experienced and for firms that are more informationally opaque supporting the notion that collateral and maturity are substitute mechanisms in mitigating agency problems we also find strong evidence that maturity increases with collateral pledges that personal collateral is associated with longer maturities than business collateral and that collateral types that better mitigate agency problems reduce the sensitivity of loan maturity to informational asymmetries and risk finally while it is argued that relationship lending may mitigate information asymmetry we find no relation between loan maturity and stronger firm creditor ties

managerial reputation and the endgame abstract this paper examines endgame behavior specifically the behavior of managers whose primary concern is to retain their jobs managers are taken to be of two types good and bad and only one manager is randomly selected as the firm s first period manager the manager unobservably chooses the mean and standard deviation limited by a mean standard deviation frontier of the process that generates his observable performance the good manager can choose higher values of the mean of the outcome generating process for given standard deviation than the bad manager can after the first of the two periods the firm s owner must choose to retain or replace her manager based upon performance in an endgame perfect bayesian equilibria of this reputation game a good manager chooses a strategy with minimal standard deviation for a given mean while a bad manager chooses a strategy of maximal standard deviation for a given mean examples of this type of behavior drawn from finance and sports are given in the paper the perfect bayesian equilibria of this game also include conservative reckless and herd managerial behavior

dynamic incentives and dual purpose accounting abstract ongoing employment relationships often give rise to implicit dynamic incentives we describe the implications of implicit incentives when firms use information about both an employee s past performance and his future productivity in a two period agency model we show that when an accounting system serves these dual objectives an employee s implicit incentives may be beneficial or detrimental to the firm as a consequence firms may prefer an accounting system that reports a single metric that combines information about past performance and future productivity over one that reports two distinct metrics one for each purpose

the use of management control mechanisms to mitigate moral hazard in the decision to outsource using archival data from the u s passenger airline industry this study examines whether management control mechanisms aimed at mitigating moral hazard explain outsourcing decisions over and above transaction cost economics tce determinants documented in prior research consistent with tce theory we find that in house production efficiencies and our proxy for transaction risk i e deriving from transaction infrequency transaction complexity and relationship specific investments significantly explain the extent of outsourcing of aircraft maintenance we extend tce insights to show that incentive delta i e the sensitivity of ceo portfolio holdings to stock price changes strengthens the negative association between production efficiencies and outsourcing while incentive vega i e the sensitivity of ceo holdings to stock return volatility weakens the negative association between transaction risk and outsourcing monitoring strengthens the negative association between in house production efficiencies and outsourcing but has no effect on the transaction risk outsourcing relation the results suggest that the use of outsourcing to achieve cost savings is promoted through both incentive contracts and monitoring but outsourcing to achieve the desired risk level is promoted only through incentive contracts

renegotiation and information revelation over time the case of optimal labor contracts the paper analyzes the issue of commitment in grossman and hart s model of optimal labor contracts under asymmetric information about firm profitability we extend their framework by allowing employment to vary over time at equidistant intervals when both parties can precommit ex ante not to renegotiate the contract this replicates the grossman hart outcome each subperiod when precommitment is not possible information revealed through the contract can create pareto improving renegotiation opportunities and the issue of optimal information revelation arises the paper analyzes the impact of ex post pareto improving renegotiations on the optimal contract

uncertainty risk and incentives theory and evidence uncertainty has qualitatively different implications than risk in studying executive incentives we study the interplay between profitability uncertainty and moral hazard where profitability is multiplicative with managerial effort investors who face greater uncertainty desire faster learning and consequently offer higher managerial incentives to induce higher effort from the manager in contrast to the standard negative risk incentive trade off this learning by doing effect generates a positive relation between profitability uncertainty and incentives we document empirical support for this prediction this paper was accepted by wei jiang finance

the assessment the economics of sport the study of sports economics has expanded rapidly in recent years in response to significantly increased demand for sport itself for economic analysis relevant to commercial litigation in sport for lively teaching material in schools and universities and for research into the incentive properties of sporting contests while much of the literature has focused on the issue of competitive balance and how to achieve it there have still been relatively few studies that apply the lessons of the economic theory of contests to the analysis of sports there remain huge opportunities both to develop our theoretical understanding of incentive mechanisms in sport and to conduct empirical research in the operation of incentives in sporting contests copyright 2003 oxford university press

on the incentives for money managers abstract money managers select weights of managed portfolios to enhance their reputation in the spot market for their services inevitably using their actions to signal their quality we develop a two asset signalling model of money managers a unique screening equilibrium and under certain parameter configurations a host of pooling equilibria survive the cho kreps intuitive criterion in all the equilibria managers behave more aggressively than they would in the absence of the signalling motive exaggerating their position in the risky asset

robustness and linear contracts abstract we consider a moral hazard problem where the principal is uncertain as to what the agent can and cannot do she knows some actions available to the agent but other unknown actions may also exist the principal demands robustness evaluating possible contracts by their worst case performance over unknown actions the agent might potentially take the model assumes risk neutrality and limited liability and no other functional form assumptions very generally the optimal contract is linear the model thus offers a new explanation for linear contracts in practice it also introduces a flexible modeling approach for moral hazard under nonquantifiable uncertainty jel d81 d82 d86

optimal incentive contracts in the presence of career concerns theory and evidence this paper studies optimal incentive contracts when workers have career concerns concerns about the effects of current performance on future compensation we show that the optimal compensation contract optimizes total incentives the combination of the implicit incentives from career concerns and the explicit incentives from the compensation contract thus the explicit incentives from the optimal compensation contract should be strongest for workers close to retirement because career concerns are weakest for these workers we find empirical support for this prediction in the relation between chief executive compensation and stock market performance

an equilibrium model of child maltreatment we propose a dynamic equilibrium model of human capital development of a child that can explain why a parent child relationship might lead to child maltreatment assuming that a parent cannot observe a child s human capital accumulation or effort and that the child s time preference develops endogenously an unstable path of the parent s beliefs regarding the child can persist in equilibrium when the parent faces a high degree of uncertainty in inferring the child s human capital the parent with an initial high estimate of the human capital then tends to underestimate the child s effort which results in persistently punitive abusive nteractions

understanding the determinants of managerial ownership and the link between ownership and performance comment abstract himmelberg et al j financial econom 53 1999 353 384 argue that fixed effects estimators should be used in examination of the relationship between managerial ownership and firm performance i show that managerial ownership while substantially different across firms typically changes slowly from year to year within a company with rational managers maximising long term utility small one year changes in ownership are not likely to reflect notable changes in incentives that would lead to substantive within year changes in performance by relying on within variation fixed effects estimators may not detect an effect of ownership on performance even if one exists

incentives between firms and within this paper reviews the significant progress in agency theory i e the economic theory of incentives during the 1990s with an eye toward applications to supply transactions i emphasize six recent models in three pairs 1 new foundations for the theory of incentive contracts 2 new directions in incentive theory and 3 new applications to supply transactions by reviewing these six models i hope to establish three things first the theory of incentive contracts needed and received new foundations second new directions in incentive theory teach us that incentive contracts are not the only source of incentives finally and especially relevant to supply transactions the integration decision is an instrument in the incentive problem

smoothing income in anticipation of future earnings abstract recent theory argues that concern about job security creates an incentive for managers to smooth earnings in consideration of both current and future relative performance we find support for this theory our evidence suggests that when current earnings are poor and expected future earnings are good managers borrow earnings from the future for use in the current period conversely when current earnings are good and expected future earnings are poor managers save current earnings for possible use in the future however sensitivity analysis indicates that we cannot rule out selection bias as a potential alternative explanation for our findings

job assignments signalling and efficiency this article analyzes a model in which information about a worker s ability is only directly revealed to the firm employing the worker other firms however use the worker s job assignment as a signal of ability three results recur throughout the analysis first wage rates tend to be more closely associated with jobs than with ability levels second there is frequently an inefficient assignment of workers to jobs i e even when a firm has complete information about a worker s output third the severity of this inefficiency tends to be negatively correlated with the level of firm specific human capital in the economy

piece rate incentive schemes this paper uses recent results from incentive theory to study heretofore informal critiques of piece rate compensation schemes the informal critiques are based on the history of failed attempts to install piece rate compensation schemes at the turn of the century the formal analysis emphasizes the importance of information and commitment in contracting the main result is as follows in a work environment characterized by hidden information and a hidden action if neither the firm nor the worker can commit to future behavior then no compensation scheme piece rate or otherwise can induce the worker not to restrict output

the dynamics of incentive contracts the paper studies a simple two period principal agent model in which the principal updates the incentive scheme after observing the agent s first period performance the agent has superior information about his ability the principal offers a first period incentive scheme and observes some measure of the agent s first period performance cost or profit which depends on the agent s ability and unobservable first period effort the relationship is entirely run by short term contracts in the second period the principal updates the incentive scheme and the agent is free to accept the new incentive scheme or to quit the strategies are required to be perfect and updating of the principal s beliefs about the agent s ability follows bayes rule the central theme of the paper is that the ratchet effect leads to much pooling in the first period first for any first period incentive scheme there exists no separating equilibrium second when the uncertainty about the agent s ability is small the optimal scheme must involve a large amount of pooling the paper also gives necessary and sufficient conditions for the existence of partition equilibria and looks at the effect of cost uncertainty

worker reputation and productivity incentives this paper examines firms problem of how to motivate risk averse workers not to shirk when workers utility functions are unknown the problem is studied in a 2 period setting in which a worker s actions today can influence not only his compensation today but the firms beliefs about his preferences firms cannot credibly commit to ignore the revealed information so workers actions today affect their future compensation contracts it is shown that in the wilson miyazaki equilibrium firms may pool workers and learn about their types gradually over time rather than inducing them to separate and reveal their types immediately

salaries and piece rates compensation can take many forms remuneration can come as pecuniary payments as fringes such as health and pension benefits or as a nonpecuniary reward such as plush office furniture that costs the firm less than it benefits the worker a significant literature has examined the trade offs between pecuniary and nonpecuniary compensation the modern work having been pioneered by rosen 1974 more recently another body of literature has examined the selection of method of total compensation ignoring the distinction between pecuniary and nonpecuniary payment this work has focused on risk and incentive factors it has resulted in comparisons of compensation based on absolute output levels to that based on relative performance it has also led to explorations of the relation of compensation to experience over the work life 2 little attention has been paid to what may be among the most important and obvious distinction in methods of compensation namely the choice between a fixed salary for some period of time that is paying on the basis of input and some workers receive compensation that is specified in advance and not directly contingent on performance instead it depends on an input measure such as hours worked for others compensation is directly related to output this essay is an attempt to predict a firm s choice of compensation method piece rates are defined more rigorously among the more important factors discussed are worker heterogeneity incentives sorting considerations monitoring costs and asymmetric information one result is that salary workers tend to be of lower quality and more homogeneous than are their piece rate counterparts numerous additional results are provided helpful comments by victoria lazear and yoram weiss are gratefully acknowledged support was provided by the department of labor and the national science foundation 1 see lazear and rosen 1981 stiglitz 1981 holmstrom 1982 green and stokey 1983 2 see lazear 1979 1981 and harris and holmstrom in press

dynamic forecasting behavior by analysts theory and evidence abstract we develop a multi period learning model to examine the relation between analysts forecasting behavior and their performance in a competitive market for banking services the surplus and the analyst s payoff which is determined through bargaining are convex in her reputation the convexity of her payoff structure and the presence of employment risk lead to a u shaped relation between the analyst s forecast boldness and prior performance and a positive relation between forecast boldness and experience we find support for these predictions in our empirical analysis significant underperformers outperformers face higher lower employment risk and are more likely to issue bolder forecasts

performance thresholds in managerial incentive contracts performance thresholds are commonly used in executive compensation contracts we examine the contractual nonlinearity associated with performance thresholds and its incentive implications incorporating a performance threshold into a standard principal agent model of a linear contract we show that pay schemes using a performance threshold are optimal by truncating a linear scheme at poor performance the threshold mitigates agency costs associated with the downside risk of production examining ceo compensation data we find evidence of the role of performance thresholds as a consequence of under threshold performance the tobit estimator is shown to increase pay performance sensitivity notably improving upon the standard ols estimator

playing for keeps pay and performance in the nba i introduction a basic insight of agency theory is that properly designed incentive contracts can align the interests of agents with those of the principal and recent empirical work shows that workers do indeed respond to financial incentives 1 contractual incentives however are not the only force motivating workers workers also have incentives to vary effort at different points of their contract cycle to increase effort just before a new contract is signed to lock in a more lucrative deal and then reduce it after a multi year contract is secured these types of contract related incentives create clear moral hazard problems but have received little empirical attention the motivating hypothesis in this paper is that imperfect information and multi year contracts create an implicit incentive for workers to strategically alter effort over the contract cycle in the year prior to signing the contract their contract year workers may exert above average effort to convince employers that they are high quality and thus raise long term compensation once the contract is signed however workers may exert less effort because wages are effectively independent of contemporaneous performance an empirical difficulty is that this moral hazard may be obscured by two factors a selection effect may lead only high quality workers to receive contracts and career concerns may provide additional incentives and dampen the post contract decline 2 this paper employs a unique dataset for professional basketball players in the national basketball association nba from 1988 to 2002 to examine the contract related incentive effects the data include contract information year signed length of contract and value of contract for every active player in 2000 and performance measures points scored rebounds assists etc throughout each player s career contract related incentive effects are estimated from changes in individual performance over the contract cycle if performance systematically improves just before signing a new contract and falls afterward some of the fluctuation is likely due to contract related incentives i also examine the traditional link between pay and past performance which is necessary for these types of incentives to be relevant the critical advantage of this data is the detailed information on individual performance individual contract status and individual pay 3 in contrast previous work on individual incentives for example lazear 2000 paarsch and shearer 2000 and shearer 2004 studied changes infirmwide compensation plans while the empirical literature on executive pay and performance for example murphy 1985 1986 jensen and murphy 1990 gibbons and murphy 1992 kaplan 1994 and hall and liebman 1998 typically examined the link between individual pay and firm performance the individual level data constructed here have the critical variation across individuals which is needed to identify the impact of these contract related incentive effects the empirical work begins with a test of the link between pay and performance which is necessary for contract related incentives to be operational not surprisingly better performers in the nba are rewarded with higher salaries and longer contracts more relevant to the incentive issue players are strongly rewarded for improvements in performance in their contract year a one point increase in a player s scoring average for example is associated with an annual salary increase of over 300 000 this link provides the crucial motivation for the hypothesis that players will exert additional effort in their contract year to lock in the better contracts that they expect to follow the data then provide strong evidence of contract related incentive effects as overall performance does in fact improve relative to a player s long run average in the contract year and then declines after a long run contract is signed

partnerships as insurance devices theory and evidence we model partnerships as mutual insurance associations in which individuals band together to insure themselves against idiosyncratic shocks to their human capital as with most forms of insurance this generates a tradeoff between efficiency and risk sharing since partners keep only a fraction of the profits they generate they will supply less than optimal effort we show that in equilibrium participants in larger partnerships keep a smaller share of their own proceeds we test and confirm this prediction using a sample of partners in law firms

strategic shirking a theoretical analysis of multitasking and specialization we provide a new theory to explain why firms multitask workers instead of specializing them workers overperform in tasks they like and underperform in tasks they dislike to favorably influence future job assignments anticipating this firms may find it optimal to commit to future multitasking to induce workers to appropriately allocate effort early in the employment relationship we show that when the product market is volatile so that future product prices are uncertain the firm s ability to credibly commit to a multitasking strategy diminishes this generates a negative relationship between multitasking and product market volatility consistent with recent empirical evidence

optimal corporate governance and compensation in a dynamic world we model long run firm performance management compensation and corporate governance in a dynamic nonstationary world many features of governance and compensation that have caused consternation among commentators arise naturally in this dynamic setting even though boards are rational and managers are powerless compensation changes depend on changes in the evolution of a latent state variable outside the manager s control board passivity is positively correlated with both the value of management compensation and the firm s good fortune managerial opportunism tends to follow sudden reversals of good fortune moreover managerial private benefits by increasing managers stake in the long run viability of the firm may actually ameliorate agency conflicts

the impact of ceo turnover on equity volatility this study investigates the effect on stock price volatility of a significant event in the life of the firm a change in its ceo we find significant long lived increases in volatility following ceo turnover after controlling for firm characteristics and marketwide volatility these increases are larger after forced departures and outside successions following voluntary departures stock prices also respond more strongly to earnings announcements following turnovers these results are consistent with more informative signals of value driving the increased volatility helping resolve two sources of uncertainty possible changes in the firm s strategy and doubt about the successor ceo s ability

on the antecedents of corporate severance agreements an empirical assessment this study of major corporations n 481 provides an empirical assessment of the effects of several corporate governance variables ceo duality boards of director composition officers and directors common stock holdings institutional common stock holdings number of majority owners on the adoption of so called severance agreements a discriminant analysis indicates a significant multivariate function wilks lambda univariate analyses suggest that the percentage of common stock held by owners and directors and number of majority stock holders are the more robust discriminators

composition and ceo duality in boards of directors an international perspective this paper provides an empirical assessment comparing board composition proportion of outside nonmanagement board members and ceo duality role of ceo and chairperson held simultaneously between samples n 150 of japanese united kingdom and united states industrial firms results indicate marked differences in these corporate governance dimensions implications regarding board independence and differences in corporate governance internationally are discussed

board management relations in small firms the paradox of simultaneous independence and interdependence the author introduces constructs based on neo classical and socio economic assumptions and argues that board management relations should be characterized by both independence and interdependence interdependence is especially important in small firms the article presents a model of directorates from research about directorates based on agency theory assumptions this model is supplemented with constructs from the theory of contractual relations whilst traditional literature tends to focus upon independence from an agency theory perspective this article argues that it is necessary to use more than one dimension of attributes regarding the board management relations in order to understand the board s contribution to company performance and that trust and solidarity is especially important in small firms board management relations described by simultaneous independence and interdependence are proposed to give the highest contribution to company performance the theoretical propositions are exemplified and supported by results of a field survey of directorates in small firms

managerial incentives and internal capital markets capital budgeting in multidivisional firms depends on the external assessment of the whole firm as well as on headquarters assessment of the divisions while corporate headquarters may create value by directly monitoring divisions the external assessment of the firm is a public good for division managers who consequently are tempted to free ride as the number of divisions increases the free rider problem is aggravated and internal capital markets substitute for external capital markets in the provision of managerial incentives the analysis relates the value of diversification to characteristics of the firm the industry and the capital market

dynamic incentives and responsibility accounting a comment abstract indjejikian and nanda j accounting and economics 27 1999 177 establish that lack of commitment results in an expected economic loss relative to a long term full commitment contract if there is inter period correlation of performance measures they attribute this loss to a ratchet effect we demonstrate the following first their proposed equilibrium is not sustained unless there is some form of limited commitment second these limited commitment assumptions need not induce a ratchet effect third the ratchet effect is neither necessary nor sufficient for an expected economic loss to occur the loss is due to the principal s inability to commit ex ante to the second period incentive rate

what does ceos pay for performance reveal about shareholders attitude toward earnings overstatements if overstatements were a symptom of the agency conflict pay for performance sensitivities should have increased in response to the additional penalties for misreporting imposed by sox our finding of their decrease is inconsistent with the view that overstatements were an unintended consequence of incentive pay prior to 2002 to corroborate our interpretation we show that i ceo pay for performance sensitivities are higher among firms whose shareholders stand to benefit from overstatements ii this cross sectional relationship weakens significantly after sox and iii the within firm decrease in pay for performance sensitivity is most pronounced among firms with high pre sox shareholder benefits from overstatements

a contracting perspective on earnings quality abstract this paper analyzes the impact of signal to noise ratios and the autocorrelation of a performance measure on the principal s welfare in dynamic agencies with renegotiation we consider the impact of changes in the persistent transitory and reversible components of accounting earnings on its usefulness in valuation versus contracting increasing the persistent components and reducing the reversible components are generally desirable for valuation but not for contracting eliminating transitory components of earnings is generally desirable for valuation but not necessarily for contracting we discuss the contracting implications of differences in the autocorrelations of accounting earnings versus stock returns

intertemporal incentives under loss aversion this paper studies the intertemporal allocation of incentives in a repeated moral hazard model with reference dependent preferences as in k oszegi and rabin 2009 besides consumption utility the agent experiences utility from the change in his beliefs about present and future eort and income when eort plans are rational the prospect of being disappointed by the outcome realization equals that of being pleasantly surprised and hence the loss averse agent is on net hurt by news in contrast to the prediction with classical preferences but consistent with real world contracts if consumption utility is not too concave and news about present income carries suciently larger weight in utility than news about future income a contract setting a current

managerial legacies entrenchment and strategic inertia this paper argues that the legacy potential of a firm s strategy is an important deter minant of ceo compensation turnover and strategy change a legacy makes ceo replacement expensive because firm performance can only partially be attributed to a newly employed manager boards may therefore optimally allow an incumbent to be entrenched moreover when a firm changes strategy it is optimal to change the ceo because the incumbent has a vested interest in seeing the new strategy fail even though ceos have no specific skills in our model legacy issues can explain the empirical association between ceo and strategy change this paper proposes a model of ceo replacement and puts forward a novel determinant for turnover decisions the legacy potential of a firm s strategy we mean by this the extent to which a manager s decisions affect future firm cash flows potentially beyond the manager s own tenure the replacement of a ceo is arguably one of the most important decisions a firm takes yet the theoretical and empirical finance literature has relatively little to say about the firm and manager specific characteristics that lead to one manager being fired and replaced by another as brickley 2003 points out the only variable that predicts turnover empirically is poor firm performance but it has little pre dictive power theoretical papers on managerial turnover tend to reduce ceo successions to a sequence of static interactions see below for more details as such they do not distinguish between a ceo who is hired and can start a fresh project or one who is constrained in this choice because he inherits a prede cessor s long term strategy our paper focuses on this latter phenomenon and investigates turnover decisions when strategy choices have a legacy potential the fact that a dynamic link exists between a ceo and his predecessor is probably more recognized in the accounting literature than in finance pourciau both authors are from the toulouse school of economics and the institut d administration des

employer learning productivity and the earnings distribution evidence from performance measures two ubiquitous empirical regularities in pay distributions are that the variance of wages increases with experience and innovations in wage residuals have a large unpredictable component the leading explanations for these patterns are that over time either firms learn about worker productivity but productivity remains fixed or workers productivities themselves evolve heterogeneously in this paper we seek to disentangle these two models and place magnitudes on their relative importance we derive a dynamic model of learning and productivity that nests both models and allows them to coexist we estimate our model on a 20 year panel of pay and performance measures from a single large firm the baker gibbsholmstrom data incorporating performance measures yields two key innovations first the panel structure implies that we have repeat measures of correlates of productivity as opposed to the empirical evidence on employer learning which uses one fixed measure second we can separate productivity from pay whereas the previous literature on productivity evolution could not we find that both models are important in explaining the data however the predominant effect is that worker productivity evolves idiosyncratically over time implying firms must continuously learn about a moving target therefore while the majority of pay dispersion is driven by variation in individual productivity wages differ significantly from individual productivity at all experience levels due to imperfect information we believe this represents a significant reinterpretation of the empirical literature on employer learning

the benefits of aggregate performance metrics in the presence of career concerns this paper considers the desirability of aggregate performance measures in light of the fact that many individuals performance incentives are driven by a desire to shape external perceptions and thus future pay in contrast to the case of explicit incentive contracts we find that when individuals actions are driven by career incentives an aggregate measure e g group or team output can sometimes alleviate moral hazard concerns and improve efficiency aggregation intermingles performance measures that may be differentially affected by skill and effort of many agents when such entanglement increases the prospect that the external market will attribute an employee s effort driven contribution to transferable skills the employee exerts higher effort as a means of posturing to the market the incentive benefit of aggregation is weighed against the incentive cost because of information loss information loss from aggregation can reduce the market s reliance on the measure and thus diminish agents desire to undertake effort to influence the measure this paper was accepted by stefan reichelstein accounting

recursive contracts firm longevity and rat races an experimental analysis abstract this paper reports the results from a laboratory experiment which investigates the structure of contracts that emerge in overlapping generation firms where future ownership is a perquisite of employment workers in the young generation are offered employment contracts designed by the firms owners who belong to the old generation when old employed workers are granted ownership rights as long as the firm continues to operate in line with theoretical predictions the results indicate that as firm longevity increases the recursive nature of the contracts leads to a rat race characterized by low wages high effort levels and rent dissipation these results have important implications for the optimal management of long lived firms such as partnerships

incentives equality and contract renegotiations theory and evidence in the chinese banking industry renegotiation plays an important role in contract theory but the empirical study of renegotiation is almost non existent in the literature using a unique dataset from the chinese banking industry we find that the large majority of managerial incentive contracts are renegotiated after performances are realized we develop a model of contract renegotiation where supervisors and managers sign incentive contracts and then renegotiate them in the unique equilibrium of the model incentive contracts are almost always renegotiated ex post even though renegotiation is fully anticipated incentive contracts affect performance the predictions of the model find strong support from our empirical results

running out of steam a political incentive perspective of fdi inflows in china drawing on the sociological literature of state bureaucracy we develop a political incentive perspective on fdi inflows we argue that political term as a core feature of career advancement in state bureaucracy influences the incentives of newly appointed government officials and in turn their efforts toward achieving the state s goal of attracting fdi due to the mandatory retirement age which limits the career advancement officials in their first terms perceive that they have better chances of promotion and hence have stronger incentives to work toward advancement than those continuing to serve in the current position for the following term we test this argument by examining chinese city government leaders and fdi inflows in their cities from 2003 to 2010 using a difference in differences design the results show that first term leaders who are newly appointed after political turnover attract more fdi inflows than continuing leaders the difference is smaller when the new leaders are close to retirement but greater if they are appointed to cities with low prior gdp performance this study offers a new perspective on intra country fdi variations and extends the literature on the role of political institutions by investigating the political incentives of government officials

the wrong kind of transparency in a model of career concerns for experts when is a principal hurt from observing more information about her agent this paper introduces a distinction between information on the consequence of the agent s action and information directly on the agent s action when the latter kind of information is available the agent faces an incentive to disregard useful private signals and act according to how an able agent is expected to act a priori this conformist behavior hurts the principal in two ways the decision made by the agent is less likely to be the right one discipline and ex post it is more difficult to evaluate the agent s ability sorting the paper identifies a necessary and sufficient condition on the agent signal structure under which the principal bene ts from committing not to observe the agent s action the paper also shows the existence of strategic complementarities between information on action and information on consequence the results on the distinction between action and consequence are then used to interpret existing disclosure policies in delegated portfolio management in particular they are consistent with hitherto puzzling evidence that mutual funds systematically overperform pension funds

herd behavior in equity markets the international evidence the paper provides evidence about herd behavior in financial market explains psycology of herd behavior the conditions and the causes under which her behavior occurs in equity market work is an overview of the recent theoretical and empirical researches on herd behavior in global financial market trying to answer the question does the herd behavior exist in equity market

sunflower management and capital budgeting in organizations ideas are often delegated for evaluation as a means of efficiently aggregating multiple information signals however those who delegate often find it impossible to separate the evaluation of the ideas they delegate from the evaluation of abilities of those delegated the task of assessing these ideas this commingling of the assessment of the idea with that of the individual agent generates a tendency for the agent to ignore his or her own information and instead attempt to confirm the superior s prior belief we refer to this as sunflower management and examine its effects on capital budgeting practices

career concerns matching and optimal disclosure policy raiders may suffer from information disadvantage since the current employer is often better informed about his workers quality when workers have career concerns and matching influences productivity the initial employer can strategically disclose information to influence incentives and matching efficiency long term complete contracts induce full disclosure when raiders are perfectly competitive the optimal short term contract induces full disclosure if raiders are perfectly competitive and the workers are risk neutral and are not liquidity constrained these conditions are not only sufficient but also almost necessary for full disclosure partial disclosure may be optimal if any of these conditions is relaxed

credit incentives and reputation a hedonic analysis of contractual wage profiles a hedonic analysis of principal agent employment contracts is developed in which workers and employers exchange labor services and contractual payment patterns within this framework tests of alternative hypotheses are formulated and applied to contract data from a unique household level survey of economic activity in rural china in 1935 the results indicate that credit market constraints motivated workers and employers contract choices that shirking by workers rather than by employers was the dominant incentive issue that reputational concerns rather than threats of termination were the key worker disciplining device and finally that the contract s third party acted as an enforcement device rather than as a matchmaker subject to the availability of matched agent principal data this structural approach to modeling agency relationships can also be used in contemporary settings

managerial incentives and capital management the paper shows how career concerns rather than effort aversion can induce a natural incongruity in risk preferences between managers and superiors a model based on learning about managerial talent is developed to study second best contractual remedies we show that the optimal wage contract is an option of the value of the manager s human capital for insurance reasons and that consequently rationing of capital is often required to counterbalance the manager s resulting incentive to overinvest rationing is strictly superior to price decentralization offering one reason for the prevalence of centralized capital budgeting procedures

the effect of risk on the ceo market this article presents a market equilibrium model of ceo assignment pay and incentives under risk aversion and moral hazard each of the three outcomes can be summarized by a single closed form equation in the presence of moral hazard assignment is distorted from positive assortative matching on firm size as firms with higher risk or disutility choose less talented ceos such firms also pay higher salaries in the cross section but economywide increases in risk or the disutility of being a ceo do not affect pay the strength of incentives depends only on the disutility of effort and is independent of risk and risk aversion if the ceo can affect firm risk incentives rise and are increasing in risk and risk aversion we calibrate the losses from various forms of poor corporate governance such as failures in monitoring and inefficiencies in ceo assignment jel g34 j33 this article presents a market equilibrium model of ceo assignment pay and incentives risk averse managers of different talents are hired in a competitive market by heterogeneous firms which vary in their size risk and level of effort required the level of pay drives the assignment of talent to firms the strength of incentives induces the efficient effort level and is determined by an optimal contracting approach our main contribution is to incorporate risk into a ceo market equilibrium in a tractable manner a large empirical literature has shown that risk is a firstorder determinant of compensation contracts demsetz and lehn 1985 garen 1994 core and guay 1999 oyer and schaefer 2004 peters 2009 peters and wagner 2009 but most theories assume risk neutrality this assumption is