On the Value of Improved Informativeness

Pierre Chaigneau

Cahiers de recherche from CIRPEE

Abstract: One of the main predictions of principal-agent theory, the “informativeness principle”, is often violated in practice. We propose an explanation that emphasizes the role played by the change in the form of the optimal contract that follows an improvement in informativeness. We show that the overall gains from a less noisy performance measure emanate from two sources: the direct effect of a change in the volatility of the performance measure, and the effect of the induced change on the form of the optimal compensation contract. We emphasize that the direct effect can either largely under-estimate or largely overtimate the overall gains from improved informativeness, and we show that these gains can even be nil in some instances.

Keywords: Executive compensation; pay-for-luck; principal-agent model; relative performance evaluation; stock-options (search for similar items in EconPapers)
JEL-codes: D86 J33 (search for similar items in EconPapers)
Date: 2012
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Persistent link: https://EconPapers.repec.org/RePEc:lvl:lacicr:1205

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