Stock Market Tournaments

Kathy Yuan and Emre Ozdenoren

No 9000, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: We propose a new theory of suboptimal risk-taking based on contractual externalities. We examine an industry with a continuum of firms. Each firm's manager exerts costly hidden effort The productivity of e ffort is subject to systematic shocks. Firms' stock prices reflect their performance relative to the industry average. In this setting, stock-based incentives cause complementarities in managerial effort choices. Externalities arise because shareholders do not internalize the impact of their incentive provision on the average effort. During booms, they over-incentivise managers, triggering a rat-race in effort exertion, resulting in excessive risk relative to the second-best. The opposite occurs during busts.

Keywords: Contractual externalities; Excessive risk-taking; Insufficient risk-taking; Stock-based incentives (search for similar items in EconPapers)
JEL-codes: D86 G01 G30 (search for similar items in EconPapers)
Date: 2012-06
New Economics Papers: this item is included in nep-cta and nep-hrm
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Related works:
Working Paper: Stock market tournaments (2012)
Working Paper: Stock Market Tournaments (2012)
Working Paper: Stock Market Tournaments (2012)
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