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Agency Contracts, Noncommitment Timing Strategies, and Real Options

Keiichi Hori () and Hiroshi Osano

No 768, KIER Working Papers from Kyoto University, Institute of Economic Research

Abstract: Given an owner's noncommitment timing strategy and a manager's hidden action, we consider how the optimal compensation contract for the manager is designed and how the corresponding timing decisions to launch the project and replace the manager are determined. Using a real options approach, we show that in comparison with the firstbest case, the higher (lower)-quality project is launched later (at the same time as the first-best case), whereas the incumbent manager is replaced earlier. We also indicate that compared with the case of the owner’s commitment timing strategy and the manager's hidden action, the higher (lower)-quality project is launched later (at the same time as the first-best case), whereas the incumbent manager is (is not necessarily) replaced later if the hidden-action problem is severe enough (is not severe enough). Unlike the folklore result of the standard moral hazard model, severance pay may serve to minimize the compensation for the manager's loss of his option value caused by loss of corporate control by committing the owner to delaying replacement of the manager if the hidden-action problem is not too severe.

Keywords: CEO turnover; executive compensation; noncommitment; real options; severance pay. (search for similar items in EconPapers)
JEL-codes: D82 G30 G34 M51 M52 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-bec, nep-cta and nep-ppm
Date: 2011-04
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Journal Article: Agency Contracts, Noncommitment Timing Strategies and Real Options (2017) Downloads
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