How Should Performance Signals Affect Contracts?

Alex Edmans, Pierre Chaigneau and Daniel Gottlieb ()

No 15755, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: The informativeness principle demonstrates that a contract should depend on informative signals. This paper studies how it should do so. Signals that indicate the output distribution has shifted to the left (e.g. weak industry performance) reduce the threshold for the manager to be paid; those that indicate output is a precise measure of effort (e.g. low volatility) decrease high thresholds and increase low thresholds. Surprisingly, "good" signals of performance need not reduce the threshold. Applying our model to performance-based vesting, we show that performance measures should affect the strike price rather than the number of vesting options, contrary to practice.

Keywords: Informativeness principle; Limited liability; Option repricing; Pay-for-luck; Performance-based vesting; Performance-sensitive debt (search for similar items in EconPapers)
JEL-codes: D86 G32 G34 J33 (search for similar items in EconPapers)
Date: 2021-02
New Economics Papers: this item is included in nep-hrm and nep-mic
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Related works:
Journal Article: How Should Performance Signals Affect Contracts? (2022)
Working Paper: How should performance signals affect contracts? (2022)
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