There exist allocations where by building up large reserves it is possible to smooth asset returns and eliminate nondiversifiable risk. This allows an ex ante Pareto improvement. We then argue that a long-lived intermediary may be able to implement this type of smoothing. We solve an optimal managerial compensation contract's wage, equity and options components, vesting dates, and control rights when firms are more complicated than standard principal-agent theory allows. A firm's owner can transfer some control rights to a manager, thereby entrenching her.
Managerial entrenchment makes deferred compensation credible but creates a hold-up problem.
Under an optimal contract a senior manager will be entrenched, make no effort, and receive apparently performance-intensive compensation. The Wharton School of the University of Pennsylvania. All rights reserved. Site designed by Singularity Design .