Optimal compensation contracts under asymmetric information concerning expected earnings

Anton Miglo

No 613, Working Papers from University of Guelph, Department of Economics and Finance

Abstract: We analyze a model with two-dimensional asymmetric information where the employer has better information about the firm's earnings potential and the employee is subject to moral hazard. The employee's contract consists of an annual bonus and stock options. We focus on two issues: how different degrees of asymmetric information about short-term earnings versus long-term earnings affect optimal contracts and second, if a signalling equilibrium exists, what information concerning the firm's performance profile over time can be conveyed by the choice of contract. We show that if the extent of long-term (short-term) asymmetric information is larger, short-term (long-term) compensation prevails. With regard to signalling, we show that firms offering more options have higher short-term performance and lower long-term performance. This provides new insights into the structure of earnings-based compensation.

Keywords: Optimal compensation; Asymmetric information; Annual bonus; Stock options. (search for similar items in EconPapers)
JEL-codes: D82 J33 M12 M52 (search for similar items in EconPapers)
Pages: 22 pages
Date: 2006
New Economics Papers: this item is included in nep-bec
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Persistent link: https://EconPapers.repec.org/RePEc:gue:guelph:2006-13

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