Contracting with Feedback

Bo Sun

No 286, 2017 Meeting Papers from Society for Economic Dynamics

Abstract: We study the effect of financial market conditions on managerial compensation structure. First, we analyze the optimal pay-for-performance in a model in which corporate decisions and firm value are both endogenous to trading due to feedback from information contained in stock prices. In a less frictional financial market, the improved information content of stock prices helps guide managerial decisions, and this information substitutes out part of direct incentive provision in compensation contracts. Thus, the optimal pay-for-performance is lowered in response to reductions in market frictions. Second, we test our theory using two quasi-natural experiments and find evidence that is consistent with the theory. Our results indicate that the financial market environment plays an important role in shaping CEO compensation structure.

Date: 2017
New Economics Papers: this item is included in nep-bec, nep-cta and nep-hrm
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Working Paper: Contracting with Feedback (2015)
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed017:286

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