Incentive Contracts for Overoptimistic Managers
AbstractThis paper analyzes an optimal incentive contract for an overoptimistic manager who overestimates the investment potential of the firm. It shows that, compared with a rational manager, an overoptimistic manager is willing to accept a linear incentive contract with a lower fixed wage. At the same time, overoptimism also leads to overinvestment. Given the trade-off between lower labor cost and investment misallocation, we show that shareholders prefer to hire an overoptimistic manager when production is not capital intensive, when the output is not too volatile and when the manager has a higher reservation utility.
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Bibliographic InfoArticle provided by AccessEcon in its journal Economics Bulletin.
Volume (Year): 32 (2012)
Issue (Month): 2 ()
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incentive contract; overoptimistic manager; behavioral finance;
Find related papers by JEL classification:
- G3 - Financial Economics - - Corporate Finance and Governance
- C7 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory
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- Anand M. Goel & Anjan V. Thakor, 2005. "Green with Envy: Implications for Corporate Investment Distortions," The Journal of Business, University of Chicago Press, University of Chicago Press, vol. 78(6), pages 2255-2288, November.
- Anand M. Goel & Anjan V. Thakor, 2008. "Overconfidence, CEO Selection, and Corporate Governance," Journal of Finance, American Finance Association, American Finance Association, vol. 63(6), pages 2737-2784, December.
- Anna Dodonova & Yuri Khoroshilov, 2006. "Optimal Incentive Contracts for Loss-Averse Managers: Stock Options versus Restricted Stock Grants," The Financial Review, Eastern Finance Association, Eastern Finance Association, vol. 41(4), pages 451-482, November.
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