Stock market tournaments

Emre Ozdenoren and Kathy Yuan

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

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 effort 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: stock-based incentives; excessive risk-taking; insufficient risk-taking; contractual externalites (search for similar items in EconPapers)
JEL-codes: D86 G00 G30 (search for similar items in EconPapers)
Pages: 43 pages
Date: 2012-07-01
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http://eprints.lse.ac.uk/119047/ Open access version. (application/pdf)

Related works:
Working Paper: Stock Market Tournaments (2012)
Working Paper: Stock Market Tournaments (2012)
Working Paper: Stock Market Tournaments (2012)
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Persistent link: https://EconPapers.repec.org/RePEc:ehl:lserod:119047

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