Changes in probability distributions and the form of compensation contracts

Pierre Chaigneau

Economic Theory Bulletin, 2015, vol. 3, issue 2, No 8, 223-232

Abstract: Abstract We consider a standard principal-agent setting where the first-order approach to the effort choice problem applies. We decompose the effect of a change in the probability distribution of performances on the form of the optimal contract into three additive components. We also consider the specific cases of a linear likelihood ratio, a rightward or leftward translation of the likelihood ratio, and CRRA utility. The results shed light on the differences between the optimal contracts derived in the literature, notably depending on whether a linear likelihood ratio or a lognormally distributed performance measure is assumed.

Keywords: Executive compensation; First-order approach; Likelihood ratio; Performance measure; Principal-agent model (search for similar items in EconPapers)
JEL-codes: D80 D86 J33 (search for similar items in EconPapers)
Date: 2015
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DOI: 10.1007/s40505-014-0051-7

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