what you don t see can t hurt you an economic analysis of morality laws this paper provides an efficiency explanation for regulation of sex drugs and gambling we propose that these morality laws can be explained by considering some activities to impose a negative externality when the activity is observed efficiency requires discretion by the individual who engages in such activities when discretion is difficult to regulate directly the activities can instead be proscribed thereby giving individuals incentive to hide their actions from others we find conditions for the first best levels of consumption and hiding to be implementable since some level of activity is efficient the optimal sanctions are not maximal ce memoire propose une explication en termes d efficacite des regulations sur les industries du sexe de la drogue et du jeu organise on suggere que ces lois de moralite peuvent etre expliquees quand on considere que certaines activites imposent une externalite negative quand l activite est observee l efficacite reclame donc une certaine discretion de la part de l individu qui s engage dans de telles activites quand cette discretion est difficile a reglementer directement les activites peuvent etre prohibees et de ce fait on donne aux individus une incitation a cacher leurs activites aux autres on etablit que des conditions de premier ordre sur les niveaux de consommation et de camouflage peuvent etre mises en application puisque qu un certain niveau d activite est efficace les peines optimales ne sont pas maximales

the value of explicit randomization in the tax code abstract consider individuals who draw income from the same random distribution but who differ in their risk aversion and who decide whether or not to report their income truthfully the government chooses the tax structure including a random tax option audit probabilities and penalties on detected evaders to maximize expected ex post social welfare high income individuals who do not evade then choose to pay either a given amount or draw from a random tax schedule this schedule ensures that everyone complies with more risk averse individuals choosing the deterministic schedule and less risk averse ones choosing the random tax option

measurement error in job evaluation and the gender wage gap i introduction wage equations are widely used to estimate the size of the pay gap between male and female dominated jobs when jobs are the unit of observation job wage rates are regressed on job attributes such as skill effort responsibility and working conditions and on the percent of female incumbents in the job the coefficient on the percent female variable estimates the size of the gender pay gap which is often taken as a measure of pay discrimination against women 1 these estimates frequently become the metric for upward adjustment of female dominated job pay to redress the discrimination summarizing the research which uses jobs as the unit of observation ehrenberg 1989 concluded that female dominated jobs are underpaid by 15 34 relative to male dominated jobs similar findings have been reported in studies which use individuals instead of jobs as the unit of observation many criticisms have been raised of these two types of studies one common criticism is that not all relevant control variables for job attributes or individual productivity may be measured or even measurable so that specification error arises if these omitted variables are correlated with the gender variable then the estimated gender pay gap incorporates legitimate differences in productivity and or job attributes however few studies have analyzed the impact of omitted factors bias empirically another common criticism is that there is measurement error in the control variables which in turn leads to biases in estimating the size of the pay gap measured job attributes are highly subjective in nature making measurement error a major problem even human capital measures of education and training are subject to error although one may easily measure years of completed education and experience it is much more difficult to measure years of effective learning or achievement only a few studies have analyzed the size of these biases empirically this paper provides the first estimates of the size of this measurement error bias in the context of job level job attribute wage equations to our knowledge only two previous studies have estimated measurement error bias using individual level human capital wage equations and both are tangential to the major question that we address in particular we find that the estimated gender pay gap is overstated by 34 44 when measurement error bias is ignored in job level wage equation analysis wage adjustments to correct the gender gap in pay which adhere strictly to such biased estimates may lead to millions of dollars in over compensation in the future job evaluation should correct for this bias and we suggest appropriate procedures in addition we provide unique evidence that previous attempts to add measures of seemingly omitted job attributes need not have reduced the bias in the measured pay gap we find that the number of job attributes which enter the wage regression is artificially increased because measurement errors reduce the measured collinearity among job factors the next section explains factor point pay plans and summarizes the few related studies section iii reviews the statistical theory of regression analysis when there is measurement error in the explanatory variables we analyze the effect of independent and correlated measurement errors between job factors on the estimated magnitude of pay discrimination section iv discusses the data and reports the empirical results from implementing various measurement error corrections the final section summarizes our findings and suggests how this study could be used to improve future factor point pay analysis ii background and related research more than half of the workers in the united states are paid according to a pay system at least partly based on job evaluation these systems establish hierarchies of jobs and pay levels using information on a common set of job attributes such as skill effort responsibility and working conditions

setting standards for credible compliance and law enforcement in this paper we examine the setting of optimal legal standards to simultaneously induce parties to invest in care and to motivate law enforcers to detect violators of the law the strategic interaction between care providers and law enforcers determines the degree of efficiency achieved by the standards our principal finding is that some divergence between the marginal benefits and marginal costs of providing care is required to control enforcement costs further the setting of standards may effectively substitute for the setting of fines when penalties for violation are fixed in particular maximal fines may be welfare reducing when standards are set optimally nous considerons dans cet article la determination en information incomplete de normes legales optimales pour a la fois inciter les citoyens a faire preuve de diligence prevention et motiver les agents de la paix a veiller au respect des lois l interaction strategique entre citoyens et agents de la paix determine l efficacite des normes choisies notre resultat principal est a l effet qu un ecart entre benefices marginaux et couts marginaux de la diligence est necessaire afin de reduire les couts d application des lois de plus les normes peuvent etre un substitut aux amendes lorsque les penalites pour infraction sont fixes des amendes maximales peuvent en particulier etre contre indiquees lorsque les normes sont optimalement determinees

an equilibrium model of incentive contracts in the presence of information manipulation abstract this paper develops an agency model in which stock based compensation is a double edged sword inducing managers to exert productive effort but also to divert valuable firm resources to misrepresent performance we examine how the potential for manipulation affects the equilibrium level of pay for performance sensitivity and derive several new cross sectional implications that are consistent with recent empirical studies in addition we analyze the impact of recent regulatory changes contained in the sarbanes oxley act of 2002 and show how policies intended to increase firm value by reducing misrepresentation can actually reduce firm value or increase the upward bias in manipulated disclosures

hand in the cookie jar an experimental investigation of equity based compensation and managerial fraud the use of equity based compensation is an increasingly popular means by which to align the incentives of top management with those of the shareholders however recent theoretical and empirical research indicates that the use of equity based compensation has the unintended consequence of creating the incentive to commit managerial fraud of the type being reported in the press this paper reports experimental evidence that shows that the amount of fraud committed by subjects is positively correlated with the level of equity as is the level of effort in addition the amount of fraud that is committed is negatively correlated with the probability of detection and subjects risk aversion the experimental design permits the identification of causal relations in the directions just noted

accuracy of response in labor market surveys evidence and implications this paper examines the extent of response errors in labor market survey data and explores the implications of such errors for economic analysis explicitly examined are responses to questions on industry occupation union status hours worked and wages analyses are based on two sources 1 a special supplement to the january 1977 current population survey that obtained data from workers and their employers and 2 an exact match of workers and their employers interviewed in the employment opportunity pilot project survey the dual nature of these surveys provides a basis for analyzing the effect of response error on a variety of economic analyses including the trade off between wages and risk the wage impact of unionism and the sensitivity of wage determination models to alternative responses to earnings questions

the role of wages and auditing during a crackdown on corruption in the city of buenos aires abstract we study the prices paid for basic inputs during a crackdown on corruption in the public hospitals of the city of buenos aires argentina during 1996 97 we find a well defined negative effect on the measures used to capture corruption prices paid by hospitals for basic homogeneous inputs decrease by 15 percent during the first 9 months of the crackdown after this period prices increase but they are still 10 percent lower than those prevailing before the crackdown relative to the precrackdown period higher wages play no role in inducing lower input prices when audit intensity can be expected to be maximal during the first phase of the crackdown but have a negative and well defined effect when audit intensity takes intermediate levels the last phase of the crackdown controlling for fixed effects we find that the wage elasticity of input prices exceeds 20 these results are consistent with the standard model of bribes of gary becker and george stigler

legal principles in antitrust enforcement we study antitrust enforcement to channel price fixing incentives of cartels through setting fine schedules and detection levels fines obey legal principles punishments fit the crime proportionality bankruptcy considerations and minimum fines bankruptcy considerations limit maximum fines ensure abnormal cartel profits and impose a challenge for optimal antitrust enforcement we derive the fine schedule and detection level that are constrained optimal under legal principles and sustainability of cartel prices this fine schedule lies below the maximum fine makes collusion on lower prices more attractive than on higher prices and hence relates to marginal deterrence literature this article is protected by copyright all rights reserved

signal jamming models of fraudulent misreporting and economic prospects an experimental investigation abstract this study uses experimental methodology to examine how the frequency and magnitude with which managers commit fraud varies with economic prospects boom middle and bust the experimental design is based on signal jamming equilibrium sje models of fraud in which managers make potentially inaccurate public reports and investors bid on shares under sje managers always exaggerate reports by a fixed amount up to the maximum possible report independent of the truth shareholders can perfectly correct managers reports except for the maximum possible report in contrast the results of the experiment show four robust deviations from sje predictions 1 managers exaggerate and shareholders correct reports according to dominated mixed strategies with probabilities significantly less than one 2 managers exaggerate more frequently and by more when outcomes are poor 3 shareholders adjust low reports by less than high reports and 4 shareholders correct relatively high reports by more in booms than busts even though managers reporting strategies are invariant to economic prospects

types and patterns an experimental east west german comparison of cooperation and solidarity abstract in a study of public good and solidarity experiments conducted in eastern and western germany we found in both games that eastern subjects behave in a significantly more selfish manner than do western subjects besides that we found that many qualitative results of both data sets are similar since our experiments were conducted in two parts of one nation we present an unusually well controlled cross cultural study by avoiding difficulties that usually arise in multinational settings we conclude that cooperation and solidarity behavior seem to depend strongly on different culture specific norms resulting from opposing economic and social histories in the two parts of germany

long horizon mean reverting stock prices revisited this paper reexamines long horizon stock returns and finds that previous work overstates the evidence of mean reversion the overstatement is largely due to the implicit weighting of ordinary least squares tests which place more weight on the depression and world war ii observations which have both large error variances and stronger mean reverting tendencies additionally the reliance on asymptotic statistics and the improper focus on only the most negative estimates of mean reversion contribute to the overstatement using generalized least squares randomization tests on the 1926 to 1987 period the random walk cannot be rejected for value or equally weighted real returns at any of 10 return horizons or by joint tests over all 10 horizons simultaneously additionally the random walk cannot be rejected for the extended 1871 to 1987 period

monitoring moral hazard asymmetric information and risk sharing in procurement contracting this article characterizes the optimal procurement contract for a monopsonistic purchaser who contracts with a risk averse supplier with private information about his costs and who contributes an unobservable effort the costs incurred by the supplier may be uncertain and the purchaser has access to a monitor of costs that may be subject to noise that complicates risk sharing the purchaser prefers to respond to the observability problem with afixed price contract and to respond to the private information problem with a cost plus contract with uncertain costs and a perfect monitor the optimal contract relieves the supplier of some risk and the purchaser prefers that the effort of the supplier be subsidized with deterministic costs and a noisy monitor the optimal contract places risk on the supplier and the purchaser may prefer that the effort of the supplier be taxed procurement of goods and services is an important form of economic exchange that is often characterized by bargaining and contracting rather than by exchange in a competitive market the procurement setting analyzed here corresponds to the case in which the purchaser is a monopsonist who contracts with a single supplier as in the case of the department of defense contracting for the delivery of a military system in such a setting a principalagent model may be a reasonable representation of the relationship between the purchaser and the supplier and the economics of the procurement arrangement is then captured in the contract when the item procured is standardized the relevant information is likely to be common knowledge and risk may be minimal in such a case a fixed price contract may satisfactorily resolve the purchaser s contracting problem in contrast the model considered here is intended to represent the procurement of a nonstandardized item about which information is incomplete costs are uncertain and observability of supplier costs by the purchaser is limited procurement thus is complicated by the conjunction of adverse selection risk sharing and moral hazard problems

earnings manipulation and the cost of capital the cost of capital the widespread use of accounting information by investors and financial analysts to help value stocks creates an incentive for managers to manipulate earnings in an attempt to influence short term stock price performance this paper examines the role of earnings management in affecting a firm s cost of capital using an agency model with multiple firms whose cash flows are correlated we demonstrate that the extent of earnings manipulation varies across the business cycle depending on a firm s earnings profile it can have stronger incentives to overstate its performance in good times or in bad times because of this dependence on the state of the economy earnings manipulation can influence a firm s cost of capital despite the forces of diversification

the impact of fine size and uncertainty on punishment and deterrence theory and evidence from the laboratory abstract increasing punishment is typically considered first choice to boost deterrence of unwarranted behavior such as false financial statements asset misappropriation stealing or corruption however if there is uncertainty on a potential violator s guilt judges and juries willingness to impose punishment may decrease in its magnitude thus increasing the magnitude of punishment may backfire when the reduced punishment probability is anticipated by potential violators based on a theoretical model our paper is the first to analyze the interdependency of violation and punishment behavior in a laboratory experiment and to contrast it to the standard partial equilibrium perspective on deterrence that considers the punishment probability to be independent of the fine size varying both the magnitude of fines and the degree of uncertainty shows that in case of legal uncertainty the deterrent effect of higher fines is far less pronounced than if the punishment probability was exogenous

product market competition incentives and fraudulent behavior abstract the present paper studies incentive provision in a model where a manager can affect the firm s stock price by exerting unobservable effort and through costly deceptive signalling and investigates the role product market competition plays in shaping shareholders trade off between inducing effort and fraud

implications of power when the ceo can pressure the cfo to bias reports abstract building on archival anecdotal and survey evidence on managers roles in accounting manipulations i develop an agency model to examine the effects of a ceo s power to pressure a cfo to bias a performance measure like earnings this power has implications for incentive compensation reporting quality firm value and information rents predictions from the model provide potential explanations for the differing results from recent empirical studies on the impact of regulatory interventions like sox and the extent to which the ceo s or cfo s incentives significantly impact on earnings management the model also identifies conditions under which either a powerful or a non powerful ceo can extract rents which can help explain mixed empirical results on the association between ceo power and excessive compensation

why do firms smooth earnings we explain why a firm may smooth reported earnings greater earnings volatility leads to a bigger informational advantage for informed investors over uninformed investors if sufficiently many current shareholders are uninformed and may need to trade in the future for liquidity reasons an increase in the volatility of reported earnings will magnify these shareholders trading losses they will therefore want the manager to smooth reported earnings as much as possible empirical implications are drawn out that link earnings smoothing to managerial compensation contracts uncertainty about the volatility of earnings and ownership structure

insider trading legislation and corporate governance this paper analyzes the impact of insider trading legislation on corporate governance in a context where large dominant shareholders can monitor underperforming companies managers have an incentive to give early warnings about adverse developments to dominant shareholders this information is effectively a bribe to induce dominant shareholders to sell their stock and refrain from intervention if insider trading is unregulated dominant shareholders collude with management at the expense of small shareholders the optimal regime forces the company to disclose all material information to the market private contracting between companies and shareholders leads to optimal insider trading regulation only if initial shareholders can enter a binding commitment otherwise large shareholders and managers recontract at the expense of small share holders enforcement also matters european union legislation requires inside information to be precise such a narrow definition creates a grey zone where information is private but cannot be classified as inside information as a result the effectiveness of corporate governance and firm value are reduced regulation in the us that treats shareholders with a stake exceeding 10 as insiders is potentially harmful

managerial incentive problems a dynamic perspective the paper studies how a person s concern for a future career may influence his or her incentives to put in effort or make decisions on the job in the model the person s productive abilities are revealed over time through observations of performance there are no explicit output contingent contracts but since the wage in each period is based on expected output and expected output depends on assessed ability an implicit contract links today s performance to future wages an incentive problem arises from the person s ability and desire to influence the learning process and therefore the wage process by taking unobserved actions that affect today s performance the fundamental incongruity in preferences is between the individual s concern for human capital returns and the firm s concern for financial returns the two need be only weakly related it is shown that career motives can be beneficial as well as detrimental depending on how well the two kinds of capital returns are aligned it is well understood by now that informational externalities may place special demands on the organization of economic exchange simple price mediated markets will frequently fail in the presence of asymmetric information in that case more elaborate contractual arrangements have to be used as substitutes for the price system lately considerable effort has been devoted to the analysis of contracting under incomplete information with the objective to understand the range of economic institutions that emerge in response to the failure of the price system the analysis of moral hazard has played a prominent role in this development moral hazard problems arise when for some reason or another transacting parties cannot contract contingent on the delivery of the good for instance in buying labour services it may be that the amount of labour supplied is not directly observable precluding a simple exchange of wage for labour as a partial remedy to this problem an imperfect mutually observed signal about the supply of labour can be used as a proxy in the contract frequently output is taken as such a proxy the drawback is that output is often influenced by other factors than labour input which induce undesirable risk into the contract one is therefore faced with a tradeoff between allocating risk associated with incomplete observability and providing incentives for a proper supply of labour gaining insight into this tradeoff is important not only for understanding contracting in the small e g managerial incentive schemes but also because it is closely related to the fundamental tension between equity and efficiency in the society as a whole while our understanding of moral hazard has advanced a lot in past years it is clear that much work remains an important question that has received little attention until

torture in counterterrorism agency incentives and slippery slopes abstract we develop a counterterrorism model to analyze the effects of allowing a government agency to torture suspects when evidence of terrorist involvement is strong we find that legalizing torture in strong evidence cases has offsetting effects on agency incentives to counter terrorism by means other than torture it lowers these incentives because the agency may come to rely on torture to avert attacks however it also increases these incentives because other efforts may increase the probability of having strong enough evidence to warrant the use of torture legalizing torture in strong evidence cases is more likely to reduce non torture efforts if these efforts are more effective at stopping attacks and less effective at turning up strong evidence when the suspect is guilty if it reduces non torture efforts it can reduce security and is more likely to do so if the attack threat is higher moreover if torture is used in strong evidence cases even if torture is banned legalizing torture in strong evidence cases necessarily reduces security if it reduces non torture efforts lastly it can increase incentives to torture even in weak evidence cases a slippery slope

the effects of exchange rate risk on economic performance the turkish experience this study examines the effects of real exchange rate risk on the economic performance for an emerging small open economy turkey when the ratios of the total foreign exchange liabilities of the central bank of the republic of turkey cbrt to 1 total reserves 2 the cbrt s reserves and 3 the cbrt s total turkish lira liabilities are taken proxy of exchange rate risk the empirical evidence suggests that the increase in exchange rate risk causes a depreciation in the real exchange rate an increase in prices and a decrease in output

plea bargaining and prosecutorial discretion a model of plea bargaining with asymmetric information is presented the prosecutor s private information consists of the strength of the case while the defendant s private information consists of h is guilt or innocence in equilibrium a fraction of cases are dismis sed because they are too likely to involve an innocent defendant in the remaining cases the prosecutor s offer of a sentence in exchange for a plea of guilty reveals the strength of the case it is shown t hat unlimited prosecutorial discretion may be socially disadvantageou s since it carries with it the requirement of sequential rationality copyright 1988 by american economic association

regulatory errors optimal fines and the level of compliance abstract this paper shows that with a hierarchical structure of enforcement regulatory errors cause the optimal penalty to be non maximal even if offenders are risk neutral and fines are pure transfers and the private benefit from violation is strictly less than the social cost for all individuals in contrast with error free monitoring no finite fine is optimal within the same hierarchical structure also full compliance is an equilibrium outcome in the presence of errors whereas in the absence of errors the regulator can achieve only partial compliance

plea bargaining with the irs extensions and further results abstract chu journal of public economics 41 1990 319 333 proposes a tax scheme called fatota under which taxpayers are given the choice between paying a fixed amount of taxes and thus being exempted from tax audit or paying only what taxpayers claim they owe and being subject to tax audits for possible evasion in this paper we extend chu s finding with regard to the pareto improving property of fatota to a more general setting including nonlinear tax penalty schedules complicated audit rules and endogenous labor supply we also show that any tax system in which the highest income taxpayer faces audit risk and or tax distortion can be pareto improved upon by the introduction of fatota we relate this result to seade s journal of public economics 7 1977 203 235 celebrated finding in the optimal taxation literature that any income tax schedule with a positive marginal tax rate at the top of the scale can be replaced by another tax schedule which is strictly pareto improving

are us stock index returns predictable evidence from automatic autocorrelation based tests this article re examines the evidence of return predictability for three major us stock indices using two recently developed data driven tests namely the automatic portmanteau box pierce test and the wild bootstrapped automatic variance ratio test in tracking the time variation of return predictability via rolling estimation window we find that those periods with significant return autocorrelations can largely be associated with major exogenous events theoretically the documented time varying nature of predictable patterns is consistent with the adaptive markets hypothesis

a search for long memory in international stock market returns abstract a major issue in financial economics is the behavior of stock returns over long as opposed to short horizons this study provides empirical evidence from the perspective of long memory analysis international evidence on long memory is explored using the morgan stanley capital international stock index data for eighteen countries two tests that are robust to short term dependence and conditional heteroskedasticity are employed a modified rescaled range test and a fractional differencing test the empirical results in general provide little support for long memory in international stock returns the findings are not sensitive to inflation adjustments in stock returns data sources and statistical methods used

efficient market hypothesis evidence from a small open economy this article studies the efficient market hypothesis for the istanbul stock exchange national 100 isen 100 price index within the lumsdaine and papell two structural breaks unit root test framework the main finding of the article shows that the isen 100 index is characterized by a unit root with two structural breaks which is consistent with the efficient market hypothesis in addition the article applies the augmented dickey fuller test runs test and the variance ratio test to test the weak form efficiency of the isen 100 the analyses are repeated for three sub periods delineated in view of the endogenously determined break points

the other side of the trade off the impact of risk on executive compensation the principal agent model of executive compensation is of central importance to the modern theory of the firm and corporate governance yet the exiting empirical evidence supporting it is quite wea

why higher punishment may reduce deterrence abstract assuming that the willingness to find a potentially innocent defendant guilty is decreasing in punishments we derive two results deterrence is decreasing when punishments are too high and deterrence maximizing punishments tend to increase in the quality of legal systems

avoidance screening and optimum enforcement a standard assumption in the economic literature on crime and punishment is that fines are costless transfers given this assumption several economists have argued that it is optimal to set the fine for engaging in a proscribed activity as high as possible the argument is a simple one raising the probability of a fine is costly since it requires devoting more resources to monitoring and apprehending individuals in contrast raising the magnitude of a fine is costless therefore the least costly way to achieve a given expected fine is to set the fine as high as possible presumably equal to the offender s wealth and adjust its probability so that the desired expected fine is obtained

marginal deterrence in enforcement of law we characterize optimal enforcement in a setting in which individuals can select among various levels of some activity all of which are monitored at the same rate but may be prosecuted and punished at varying rates for less harmful acts marginal expected penalties ought to fall short of marginal harms caused indeed some range of very minor acts should be legalized for more harmful acts whether marginal expected penalties should fall short of or exceed marginal harms depends on the balance between monitoring and prosecution punishment costs we also explore how the optimal enforcement policy varies with changes in these costs

the economics of fraudulent accounting we argue that earnings management and fraudulent accounting have important economic consequences in a model where the costs of earnings management are endogenous we show that in equilibrium low productivity firms hire and invest too much in order to pool with high productivity firms this behavior distorts the allocation of economic resources in the economy we test the predictions of the model using firmlevel data we show that during periods of suspicious accounting firms hire and invest excessively while managers exercise options when the misreporting is detected firms shed labor and capital and productivity improves our firm level results hold both before and after the market crash of 2000 in the aggregate our model provides a novel explanation for periods of jobless and investment less growth

reasonable doubt and the optimal magnitude of fines should the penalty fit the crime models of the enforcement compliance relationship have assumed that both the probability and magnitude of fines are independent choice variables of policy makers these models indicate that it may be optimal to monitor with lowfrequency but to inflict uniformly maximal penalties for all infractions detected this article shows that if the judicial system is built on the reasonable doubt test then the penalty and the probability of conviction are not independent in particular as the penalty increases the probability of conviction falls as a result uniformly maximal penalties may actually encourage crime rather than deter it this article shows that optimal fines should rise with the severity of the infraction that is the penalty should fit the crime models of the enforcement compliance relationship generally treat both the probability and magnitude of fines as independent choice variables of the government this approach has led becker 1968 and others to conclude that it is optimal to set uniformly maximal penalties for all crimes and to set the probability of conviction at the minimum level necessary to enforce compliance with the law while this normative prescription is natural and intuitive there still remains a larger positive question of why in most nations of the world penalties are not uniformly high but rather rise with the severity of the crime one possible resolution of the positive and normative questions may lie in the fact that penalties and probabilities of conviction are not generally independent convictions are typically determined by judges or jurors who are instructed to convict only if the evidence convinces them beyond a reasonable doubt that the accused is guilty psychologists however have found that a juror s willingness to convict may be influenced by more than just the evidence jurors are very sensitive to the potential penalties that defendants may pay

annual bonus schemes and the manipulation of earnings abstract using confidential data of executive specific short term bonus plans we investigate the extent to which executives manipulate earnings to maximize the present value of bonus plan payments as such this paper extends the work of healy 1985 like healy we find evidence consistent with the hypothesis that managers manipulate earnings downwards when their bonuses are at their maximum unlike healy we find no evidence that managers manipulate earnings downwards when earnings are below the minimum necessary to receive any bonus we demonstrate that healy s results at the lower bound are likely to be induced by his methodology

managers compensation and misreporting a costly state verification approach i introduction the use of stock options in compensation packages as a way of providing the firm management with the right incentives has been quite popular in the 1990s the favor encountered by options started however to decrease in the past few years the decline in the use of option grants in top executives compensation packages occurred mainly as a reaction to the recent accounting scandals which has prompted the design of alternative stock based compensation schemes e g restricted stock grants or indexed options as reported by hall and murphy 2003 the grant date value of options assigned to all employees of an average standard poor s 500 firm measured in millions of 2002 constant us increased from 22 in 1992 to 238 in 2000 and subsequently decreased to 141 in 2002 although percentages varied from year to year the ceos share of the total grant has fallen from about 7 in the mid 1990s to less than 5 in 2000 2002 1 the decline in the use of options for top management is widely confirmed according to a pearl meyer partners study for the new york times stock option grants that accounted for 52 of the pay of the average ceo of a major company in 2002 were down to an estimated 35 in 2003 a recent watson wyatt report states that the value of new stock option awards granted to ceos at large companies fell by nearly 60 between 2001 and 2003 with the average value of new stock option grants declining from us 10 2 million in 2001 to us 4 2 million in 2003 the decline in options has been softened by the sharp increase in restricted stock grants and other long term incentive award values 2 in this paper we aim to reevaluate the role of stock options as an ingredient of top management compensation packages able to align the interests of managers and shareholders avoiding misreporting of the firm value at the same time 3 in a costly state verification csv model with moral hazard we show that incentive compatible contracts inducing both incentive alignment and truthful revelation of the firm value must entail a strictly convex compensation schedule that is a fixed payment wage when the firm value is sufficiently low and a state contingent claim increasing in the firm value otherwise a simple and commonly observed way to achieve a convex compensation scheme is to design a remuneration including a fixed wage and a call option on the firm equity as we will show such remuneration allows on the one hand to preserve top management incentives providing for a compensation increasing in equity value and on the other hand to reduce the verification costs that must be incurred to avoid misreporting as verification is not needed in the region where the remuneration is fixed 4 options are by no means the only way to achieve a convex compensation however many other schemes having otherwise desirable properties over options do not have the convex shape discussed above for instance combining a fixed wage with restricted stock grants defines a compensation linearly increasing in the firm s equity value which does not allow to reduce misreporting verification costs that always have to be sustained in this case using an incentive compatible compensation scheme fixed wage plus call options we characterize the contract offered by the firm under the assumption of a deterministic and perfect audit technology showing that for any given value of the option package the manager should receive the largest possible number of options at the highest strike price allowing shareholders to reduce the expected verification cost furthermore the strike price of the option turns out to be determined by incentive compatibility i e the option value must be such that the manager is induced to exert the desired level of effort while the magnitude of the fixed wage is defined by individual rationality there are three main policy implications of our analysis

how common are intentional gaap violations estimates from a dynamic model this paper uses data on detected misstatements earnings restatements and a dynamic model to estimate the extent of undetected misstatements that violate gaap the model features a ceo who can manipulate his firm s stock price by misstating earnings i find the ceo s expected cost of misleading investors is low the probability of detection over a five year horizon is 13 91 and the average misstatement if detected results in an 8 53 loss in the ceo s retirement wealth the low expected cost implies a high fraction of ceos who misstate earnings at least once at 60 with 2 22 of ceos starting to misstate earnings in each year 2003 2010 inflation in stock prices across ceos who misstate earnings at 2 02 and inflation in stock prices across all ceos at 0 77 wealthier ceos manipulate less and the average misstatement is larger in smaller firms this article is protected by copyright all rights reserved

the impact of performance based compensation on misreporting abstract this paper examines the effect of ceo compensation contracts on misreporting we find that the sensitivity of the ceo s option portfolio to stock price is significantly positively related to the propensity to misreport we do not find that the sensitivity of other components of ceo compensation i e equity restricted stock long term incentive payouts and salary plus bonus have any significant impact on the propensity to misreport relative to other components of compensation stock options are associated with stronger incentives to misreport because convexity in ceo wealth introduced by stock options limits the downside risk on detection of the misreporting

exposing false advertising countries rely on different public and private agents to enforce consumer protection and fair competition regulations to analyze the repercussions of different regimes on social welfare we consider the possibility of false advertising by a firm in an environment with duopolistic competition and with consumers who can be rational or naive regarding the trustworthiness of advertising claims we compare the incentives for and outcomes of false advertisement verification and injunction requests made by one of three parties a government agency with a broad focus maximizing ex post total welfare and two narrowly focused parties the first a public or private party focused on consumer welfare net of its own enforcement costs and the second a competitor interested exclusively in its own profits considering ex ante welfare we find that having a narrowly focused party as the plaintiff can be optimal due to government agency commitment problems the optimal regime depends on both the share of the population s naive consumers and the level of enforcement costs resume denonciation de la publicite mensongere pour veiller a l application des reglementations en matieres de protection des consommateurs et de concurrence loyale les etats s appuient sur differents regimes de controle representes par des agents publics et prives afin d analyser les repercussions de ces differents regimes sur le bien etre nous evaluons la possibilite qu une entreprise puisse diffuser de la publicite mensongere dans un environnement concurrentiel duopolistique avec des consommateurs potentiellement rationnels ou naifs relativement a la veracite des allegations publicitaires nous comparons les mesures incitatives pour controler la publicite mensongere et leurs resultats ainsi que les mises en demeure initiees par l une de ces trois parties une agence gouvernementale a visee large aux fins de maximisation totale du bien etre ex post et deux autres parties a visee plus ciblee l une publique ou privee tournee vers le bien etre des consommateurs deduction faite de ses propres co ts de mise en uvre et l autre representee par un concurrent s interessant exclusivement a ses propres profits en tenant compte du bien etre ex ante et en raison des problemes d engagement des agences gouvernementales nous constatons qu une procedure peut s averer optimale des lors que le demandeur represente une partie a visee plus ciblee le regime optimal depend a la fois de la proportion de consommateurs naifs et du niveau des couts de mise en uvre

crime versus justice is there a trade off abstract when society is divided into two groups with different actual or perceived crime rates maintaining a low crime rate minimizing the total number of innocent individuals convicted of a crime and keeping the probability of wrongly convicting an innocent individual equal across groups are incompatible social goals this paper fully develops these trade offs an empirical application of the model finds that these trade offs may be substantial specifically we estimate that innocent black americans would be roughly eight times more likely to be wrongly convicted of murder than innocent white americans if society placed no value on equality when it comes to convictions however we estimate that eliminating inequality entirely could cost up to 1 900 lives annually because of a rise in the murder rate estimates reveal similar findings for gender inequality in highlighting this serious dilemma this paper suggests a need for awareness of costs of crime reduction policies

manipulation and equity based compensation economists have long argued that a strong linkage between compensation and performance is essential for resolving the agency problem created by the separation of ownership and control in particular michael c jensen and kevin j murphy 1990 were very influential in giving impetus to the view that such incentives were in need of strengthening compared to accounting benchmarks the stock price is more forward looking and it is responsive to all value relevant information including informal and unverifiable items of news this makes stock and or option awards an important part of optimal incentives and constitutes a primary reason for seeking a public listing as argued by bengt holmstrom and jean tirole 1993 until recently however theories of optimal executive compensation have generally ignored the possibility that the stock price can be manipulated or falsified it is becoming increasingly clear that this is an important issue in a spate of recent scandals companies have misled the investing public by vastly overstating their profitability and prospects and substantive restatements of company accounts have become increasingly commonplace a growing body of empirical evidence suggests that executive pay in its current form may be at least in part responsible recent studies finding a link between unusual movements in performance measures such as accounting yardsticks and publicly disclosed price sensitive information and compensation include daniel bergstresser and thomas philippon 2006 natasha burns and simi kedia 2006 and peng and roell forthcoming thus the benefits of stock based incentives should be weighed against their side effects this paper models optimal executive compensation in a setting where managers are in a position to influence the public perception of manipulation and equity based compensation

criminal deterrence in the reduced form a new perspective on ehrlich s seminal study i introduction perhaps the best known and most influential econometric analysis of the deterrent effect of criminal penalties is isaac ehrlich s 1973 participation in illegitimate activities a theoretical and empirical analysis he reported large and significant marginal deterrent effects of penalties for a wide range of crimes ehrlich s work was heavily criticized on methodological grounds and many subsequent studies have contradicted his results while still others have not 1 nonetheless ehrlich s work remains an important hallmark in the study of criminal deterrence this note is motivated by recent research that indicates that penalties may have indirect consequences that could reduce their deterrent effect higher penalties could for instance encourage a criminal to spend more effort avoiding detection and prosecution malik 1990 and snyder 1990 for instance as lott 1987 1992 shows higher penalties may increase the amount of money criminals spend on legal defense 2 this means that higher penalties could reduce the probability of apprehension and conviction in addition a feature of the legal system may generate another way for higher penalties to reduce the probability of punishment this feature is that judges and juries must apply the reasonable doubt test to their decision to convict a defendant assume that jurors establish the level of doubt which is reasonable by finding the threshold that will minimize expected social losses if juries like criminals have a forecast of likely penalties then as the expected penalty rises the cost of an incorrect conviction also rises this means the juror s threshold level of reasonable doubt will rise as well the effect is to reduce the probability that a given defendant will be convicted andreoni 1991 if either the avoidance or the reasonable doubt effect is significant then this will mitigate the direct deterrent effect of penalties on crime rates reexamining ehrlich s work we see that his prime objective was to identify a single equation in a three equation simultaneous equations system that being the equation predicting crime rates he found significant negative coefficients on penalties which he took as evidence for his theoretical model of criminal behavior in which criminals could be deterred by higher penalties if more recent theories are correct in claiming that higher penalties may also decrease the chance of conviction then ehrlich s estimation of the single equation will not tell a complete story in particular we must estimate a reduced form model which will capture both the direct and indirect effects of penalties on crime rates this paper will address these questions using ehrlich s original data replicating ehrlich s regressions we find strong direct deterrent effects of penalties however we also find that increased penalties have a significant negative affect on the probability of conviction as predicted by the theoretical studies we combine these effects by examining the reduced form equations for both crime rates and probabilities of conviction we find that the total effect of penalties on crime rates is approximately zero for all twelve crime categories considered but that the effects of penalties on probabilities of conviction remain negative and significant in the reduced form equations this note allows for two general conclusions first we provide some evidence for theoretical models that predict that penalties may reduce the probability that criminals will be convicted second and more importantly despite one s views on the many widely discussed methodological issues surrounding ehrlich s seminal work when generalized to account for possibilities that higher penalties may reduce the probability of conviction his data generate much different policy implications than those widely adopted at the time of his paper s publication ii specification this section discusses the specification of the structural equations for ehrlich s original study

competition for talent under performance manipulation abstract we study the effects of introducing competition for ceos assuming that the talent of ceos is not observable and that they can misreport their performance without competition for talent firms maximize their profits by offering inefficiently low powered incentive contracts competition for talent removes those inefficiencies but it leads to excessively high powered incentive contracts causing efficiency losses that can be more severe than the inefficiencies that competition mitigates if misreporting is not a concern however then competition for talent has unambiguously positive effects on efficiency

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

efficiency of the turkish stock exchange with respect to monetary variables a cointegration analysis in this study we test the semistrong form of the efficient market hypothesis in turkey by using the recently developed techniques in time series econometrics namely unit roots and cointegration the long run relationship between stock prices and inflation is investigated by assuming the possible existence of a proxy effect conclusions are made as to the efficiency of the turkish stock exchange and its possible implications for investors to our knowledge this is among the pioneering studies conducted in an emerging market that uses an updated econometric methodology to allow for an analysis of long run steady state properties together with short run dynamics

a signal jamming theory of predation we propose a new theory ofpredation based on signal jamming in our model the predator s characteristics are common knowledge while the entrant is uncertain of his own future profitability the entrant uses his current profit to decide whether to remain in the market and the predator preys to jam or interfere with this inference problem thus our model differs from those based on reputation effects in which the predator preys to signal information about himself

sex discrimination in faculty salaries evidence from a historically women s university during the past several years a number of studies have appeared in this review and elsewhere examining the earnings and promotion of women faculty a finding common to most of these studies is that the female male salary differential is smallest at entry level but widens over time 2 indeed george johnson and frank stafford state after presenting such evidence for michigan state university we believe this qualitative result would be observed for any university in the united states for which the sample size is sufficiently large 1974 p 899 while the qualitative findings of faculty salary studies have been similar interpretations have differed on the one hand the human capital view attributes the widening sex differential or flatter female earnings profile to differences in acquired skill and productivity this literature emphasizes differences in continuous labor market experience hours of work and the relative teaching research division of labor on the other hand the discrimination view attributes the widening differential to increased labor market discrimination with respect to experience the sex differential is smallest at entry level where universities must compete and pay prevailing salaries to attract incoming faculty members however discrimination is more easily exercised in the internal university labor market by male faculty and administrators as job mobility lessens with age because of fixed costs tied moves 3 university specific job training a shorter benefit span etc the strongest evidence supporting the discrimination view is the existence of significant unexplained salary differentials even where detailed data exist on research and teaching performance the purpose of this note is to examine the salary structure at a large university which was historically the state s university for women but is now fully coeducational to our knowledge no other such study is available comparison of results from such a study with those already in the literature can shed light on the interpretation of salary differential studies we find somewhat surprisingly an exception to the finding by johnson and stafford and others of a widening femalemale salary differential with experience apart from some qualifications discussed below we find a small differential at entry but little difference in the reward structure to men and women with respect to experience ceteris paribus alternative interpretations of this evidence are provided while we cannot clearly test between the human capital and discrimination explanations for salary differentials our evidence strongly suggests that universities can and do exercise significant discretion in the awarding of salaries discretion which is presumably made possible by the not for profit nature of these institutions see armen alchian and reuben kessel section i briefly describes the data source while section ii examines specification and then tests for functional form section iii university of north carolina greensboro we thank terry g seaks and frank stafford for helpful suggestions we are equally responsible for the contents of the paper a partial list includes george johnson and frank stafford with later comments by steven farber and by myra strober and alice quester nancy gordon thomas morton and ina braden emily hoffman david katz marianne ferber and jane loeb ferber and betty kordick ferber loeb and helen lowry and james koch and john chizmar 2 there is debate over whether the differential begins to narrow late during the working life as argued by johnson and stafford see johnson and stafford 1977 and ferber loeb and lowry 3viewing mobility within a household context see jacob mincer the potential for discrimination against married women faculty may be higher than with male or unmarried female faculty

optimal pollution standards and non compliance in a dynamic framework in this paper we present a stackelberg differential game to study the dynamic interaction between a polluting firm and a regulator who sets pollution limits overtime at each time the firm settles emissions taking into account the fine for non compliance with the pollution limit and balances current costs of investments in a capital stock which allows for future emission reductions we derive two main results first we show that the optimal pollution limit decreases as the capital stock increases while both emissions and the level of non compliance decrease second we find that offering fine discounts in exchange for firm s capital investment is socially desirable we numerically obtain the optimal value of such discount which crucially depends on the severity of the fine in the limiting scenario with a very large severity of the fine the optimal discount implies that no penalties are levied since the firm shows adequate adaptation progress through capital investment

cutting environmental penalties to protect the environment abstract when pollutants are persistent and the polluter has private information regarding the occurrence of accidental releases and the cost of clean up we show that the penalty regime which most effectively protects the environment will involve penalties which are less than maximal the extent to which these penalties will be less than maximal is interestingly a non monotonic function of the persistence of the hazardous substance being handled with the highest penalties being appropriate in the case of pollutants of medium persistence our analysis complement consisting work which predicts that setting the penalties faced by some classes of violator below their maximal level may be compliance enhancing see for example harrington journal of public economics 1988 37 29 53 greenberg journal of economic theory 1984 32 1 13 kambhu journal of regulatory economics 1989 1 103 114

interpreting wage gaps of disabled men the roles of productivity and of discrimination using the uk labour force survey we study wage gaps for disabled men after the introduction of the disability discrimination act we estimate wage gaps at the mean and at different quantiles of the wage distribution and decompose them into a part explained by differences in workers and job characteristics a part that can be ascribed to health related reduced productivity and a residual part the large original wage gaps reduce substantially when we control for differences in education and occupation although significant residuals remain however when we isolate productivity differences between disabled and nondisabled workers the residual wage gap becomes insignificant in most cases

making the crime fit the penalty the role of prosecutorial discretion under mandatory minimum sentencing abstract this paper empirically documents one way in which prosecutorial discretion may be used to dampen the effects of mandatory minimum sentencing laws specifically prosecutors can use their discretion over prosecution charges to circumvent a mandatory minimum sentencing law for some defendants by prosecuting defendants who were initially arrested for the crime targeted by the sentencing law for lesser crimes not covered by the law i document the use of such discretion with respect to several state three strikes type repeat offender laws imposed throughout the 1990s and i find that prosecutors become significantly more likely to lower a defendant s prosecution charge to a misdemeanor when conviction for the initial felony arrest charge would lead to sentencing under a three strikes law moreover accounting for such behavior is important as i show that failure to do so can lead to overstating the effects of these laws on average sentencing by almost 30 percent

self reporting investigation and evidentiary standards abstractself reporting schemes have become a substantial part of law enforcement this paper analyzes the optimal use of such schemes when the authority cannot commit to an ex post investigation effort i show that this leads to a negative relationship between self reporting incentives and investigation effort three main conclusions arise first violators self report with a probability of 1 if and only if full amnesty is offered second self reporting schemes are not efficient when the level of harm of the act is high finally authorities can increase the incentives to self report when they convict without hard evidence however a hard evidence standard provides more deterrence and is weakly welfare superior

managerial manipulation corporate governance and limited market participation abstract the low fraction of u s households participating in equity markets despite the sizable equity premium has been referred to as the stock market participation puzzle we explore a part of this puzzle by examining the role of managerial manipulation in accounting for the properties of stock market participation we show that when investors have heterogeneous beliefs about managerial manipulation investors who are relatively pessimistic about reporting quality consider stock prices unjustified by the underlying firm value and rationally withdraw from the stock market giving rise to limited market participation in equilibrium our model also suggests that tightened accounting standards have the effect of reducing the dispersion of investor beliefs regarding financial reporting and thus help encourage stock market participation consistent with this idea we find that stronger accounting and governance policies are associated with higher market participation across countries

should the wealthy be able to buy justice this paper shows that allowing wealthy individuals to influence the outcome of their trials through the purchase of legal services can be consistent with the optimal penalty literature using this analysis the author reviews some of the advantages and disadvantages of varying the length of jail terms versus varying the probability of conviction finally implications for the bail prosecutorial and plea bargaining systems are examined copyright 1987 by university of chicago press

auditing and competitive bidding in the public sector abstract this paper investigates the impact of a ministry s budget size on the choice between auditing a niskanen bureau and employing competitive bidding in the provision of a publicly funded good the ministry s marginal expected payoff increases fastest with budget size for auctioning as opposed to auditing however the ministry is shown to switch from a purely public provision to a competitive provision as the budget size increases even if expected fixed costs favor the audit the study contributes to the literature by extending the niskanen framework and by endogenizing the institutional arrangements for the provision of public sector goods

is there a link between executive equity incentives and accounting fraud we compare executive equity incentives of firms accused of accounting fraud by the securities and exchange commission sec during the period 1996 2003 with two samples of firms not accused of fraud we measure equity incentives in a variety of ways and employ a battery of empirical tests we find no consistent evidence that executive equity incentives are associated with fraud these results stand in contrast to assertions by policy makers that incentives from stock based compensation and the resulting equity holdings increase the likelihood of accounting fraud

a general equilibrium model of crime commission and prevention abstract the model developed in this paper features a general equilibrium specification of the relationships among criminals victims of crime and a law enforcement agency these relationships are employed to endogenously derive an explicit intuitively appealing technology of crime commission and prevention the solution to the present model is therefore obtained with a set of more elementary assumptions than the previous literature where arbitrary curvature assumptions are invoked

endogenous public sector budgeting to centralize or not in this paper the impact of budget size on a government s choice to centralize or decentralize the budgetary process is investigated using asymmetric information differing preferences and endogenous budgetary arrangements the central government chooses between a budgetary process that excludes the regional board centralization and one that includes the board decentralization in the determination of program budget levels it is predicted that the central government will decentralize the budgetary process at low and centralize at high overall budget levels switching from decentralization to centralization is predicted to

additional evidence on bonus plans and income management abstract we extend healy 1985 by examining the relation between discretionary accruals and bonus plan bounds for a sample of 102 firms for the 1980 1990 period contrary to healy we find that when earnings before discretionary accruals fall below the lower bound managers select income increasing discretionary accruals and vice versa we believe that our results are more consistent with the income smoothing hypothesis than with healy s bonus hypothesis however mechanical selection bias in portfolio formation cannot be entirely ruled out as an alternative explanation for our results

do we punish high income criminals too heavily many critics believe that since high income criminals can afford to purchase better legal services they are less severely punished than poor criminals who commit equivalent crimes others are concerned that the penalties imposed on criminals are too small this paper shows that ignoring the effect conviction has on later earnings dramatically underestimates the total monetary penalty paid by those convicted and that the penalty structure is extremely progressive where evidence on the probability of conviction is available it shows that the highest income criminals face the highest expected penalties

the causal nexus between oil prices and equity market in the u s a regime switching model abstract the aim of this paper is to analyse the causal link between monthly oil futures price changes and a sub grouping of s p 500 stock index changes the causal linkage between oil and stock markets is modelled using a vector autoregressive model with time varying parameters so as to reflect changes in granger causality over time a markov switching vector autoregressive ms var model in which causal link between the series is stochastic and governed by an unobservable markov chain is used for inferring time varying causality although we do not find any lead lag type granger causality the results based on the ms var model clearly show that oil futures price has strong regime prediction power for a sub grouping of s p 500 stock index during various sub periods in the sample while there is a weak evidence for the regime prediction power of a sub grouping of s p 500 stock indexes the regime prediction non causality tests on the ms var model show that both variables are useful for making inference about the regime process and that the evidence on regime prediction causality is primarily found in the equation describing a sub grouping of s p 500 stock market returns the evidence from the conditional non causality tests shows that past information on the other series fails to improve the one step ahead prediction for both oil futures and stock returns

do hedge funds manage their reported returns f or funds with high incentives and more opportunities to inflate returns we find that i returns during december are significantly higher than returns during the rest of the year even after controlling for risk in both the time series and the cross section and ii this december spike is greater than for funds with lower incentives and fewer opportunities to inflate returns these results suggest that hedge funds manage their returns upward in an opportunistic fashion in order to earn higher fees finally we find strong evidence that funds inflate december returns by underreporting returns earlier in the year but only weak evidence that funds borrow from january returns in the following year jel g10 g19 g23 g30

why do increased arrest rates appear to reduce crime deterrence incapacitation or measurement error this paper attempts to discriminate between deterrence incapacitation and measurement error as explanations for the negative empirical relationship between arrest rates and crime measurement error cannot explain the observed patterns in the data incapacitation suggests that an increase in the arrest rate for one crime will reduces all crime rates deterrence predicts that an increase in the arrest rate for one crime will lead to a rise in other crimes as criminals substitute away from the first crime empirically deterrence appears to be the more important factor particularly for property crimes jel k42

the optimal shape of compensation contracts with earnings management the research question of why earnings management occurs is decomposed into two questions in this article which component of executive compensation generates incentives for earnings management and why is the compensation structured that way in the first place we first use as a dynamic stochastic equilibrium model to show that big bath and earning overstatement can co exist as equilibrium financial reporting strategies when thresholds are used in compensation contracts in order to understand the use of performance thresholds as a prevailing compensation strategy in practice we then derive the optimal compensation contract when the manager is privately informed about economic earnings and his expertise in managing earnings equilibria exist in which the inactive region below a threshold in compensation should be economically significant

executive compensation a modern primer this article studies traditional and modern theories of executive compensation bringing them together under a simple unifying framework accessible to the general interest reader we analyze assignment models of the level of pay and static and dynamic moral hazard models of incentives and compare their predictions to empirical findings we make two broad points first traditional theories find it difficult to explain the data suggesting that compensation results from rent extraction by ceos however more modern shareholder value theories that arguably better capture the ceo setting do deliver predictions consistent with observed practices suggesting that these practices need not be inefficient second seemingly innocuous features of the modeling setup often made for tractability or convenience can lead to significant differences in the model s implications and conclusions on the efficiency of observed practices we close by highlighting apparent inefficiencies in executive compensation and additional directions for future research