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When to fire a CEO: optimal termination in dynamic contracts

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  • Spear, Stephen E.
  • Wang, Cheng

Abstract

Existing models of dynamic contracts impose that it is both optimal and feasible for the contracting parties to bind themselves together forever. This paper introduces optimal terminatin in dynamic contracts. We modify the standard dynamic agency model to include an external labor market which, upon the dissolution of the contract, allows the firm to return to the labor market to seek a new match. Under this simple closure of the model, two types of terminations emerge. Under one scenario, the agent is fired after a sequence of bad outputs and she becomes too poor to be punished effectively. Under the second scenario, the agent is forced out after a sequence of good outputs and she becomes too expensive to motivate. We then use the model to study issues of CEO termination and firm dynamics.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Economic Theory.

Volume (Year): 120 (2005)
Issue (Month): 2 (February)
Pages: 239-256

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Handle: RePEc:eee:jetheo:v:120:y:2005:i:2:p:239-256

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Web page: http://www.elsevier.com/locate/inca/622869

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References

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  1. Wang, Cheng, 1997. "Incentives, CEO Compensation, and Shareholder Wealth in a Dynamic Agency Model," Journal of Economic Theory, Elsevier, vol. 76(1), pages 72-105, September.
  2. Stiglitz, Joseph E & Weiss, Andrew, 1983. "Incentive Effects of Terminations: Applications to the Credit and Labor Markets," American Economic Review, American Economic Association, vol. 73(5), pages 912-27, December.
  3. Spear, Stephen E & Srivastava, Sanjay, 1987. "On Repeated Moral Hazard with Discounting," Review of Economic Studies, Wiley Blackwell, vol. 54(4), pages 599-617, October.
  4. Wang, Cheng, 1997. "Incentives, CEO Compensation and Shareholder Wealth in a Dynamic Agency Model," Staff General Research Papers 5170, Iowa State University, Department of Economics.
  5. Shapiro, Carl & Stiglitz, Joseph E, 1984. "Equilibrium Unemployment as a Worker Discipline Device," American Economic Review, American Economic Association, vol. 74(3), pages 433-44, June.
  6. Phelan Christopher, 1995. "Repeated Moral Hazard and One-Sided Commitment," Journal of Economic Theory, Elsevier, vol. 66(2), pages 488-506, August.
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Citations

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Cited by:
  1. Leonardo Martinez, 2009. "Reputation, career concerns, and job assignments," Working Paper 06-01, Federal Reserve Bank of Richmond.
  2. Wang, Cheng, 2006. "Equilibrium Layoff As Termination of a Dynamic Contract," Staff General Research Papers 12704, Iowa State University, Department of Economics.
  3. Fabel, Oliver & Kolmar, Martin, 2012. "Do parachutes discipline managers? An analysis of takeover battles," International Review of Law and Economics, Elsevier, vol. 32(2), pages 224-232.
  4. Josepa Miquel-Florensa, 2013. "Dynamic contractual incentives in the face of a Samaritans’s dilemma," Theory and Decision, Springer, vol. 74(1), pages 151-166, January.
  5. Ulf Axelson & Philip Bond, 2011. "Investment banking careers: An equilibrium theory of overpaid jobs," FMG Discussion Papers dp690, Financial Markets Group.
  6. Keiichi Hori & Hiroshi Osano, 2013. "Managerial Incentives and the Role of Advisors in the Continuous-Time Agency Model," Review of Financial Studies, Society for Financial Studies, vol. 26(10), pages 2620-2647.
  7. Cheng Wang, 2012. "Optimal Self-enforcing and Termination," 2012 Meeting Papers 433, Society for Economic Dynamics.
  8. Wang, Cheng, 2011. "Termination of dynamic contracts in an equilibrium labor market model," Journal of Economic Theory, Elsevier, vol. 146(1), pages 74-110, January.
  9. Martinez, Leonardo, 2009. "A theory of political cycles," Journal of Economic Theory, Elsevier, vol. 144(3), pages 1166-1186, May.
  10. Martin Szydlowski, 2012. "Ambiguity in Dynamic Contracts," Discussion Papers 1543, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  11. Ohlendorf, Susanne & Schmitz, Patrick W., 2011. "Repeated moral hazard and contracts with memory: The case of risk-neutrality," MPRA Paper 28823, University Library of Munich, Germany.
  12. Casamatta, Catherine & Guembel, Alexander, 2007. "Managerial Legacies, Entrenchment and Strategic Inertia," IDEI Working Papers 442, Institut d'Économie Industrielle (IDEI), Toulouse.
  13. Wang, Cheng, 2005. "Termination of Dynamic Contracts in an Equilibrium Labor Market Model," Staff General Research Papers 12403, Iowa State University, Department of Economics.
  14. Ronald W. Anderson & Maria Cecilia Bustamante & Stéphane Guibaud, 2012. "Agency, firm growth, and managerial turnover," LSE Research Online Documents on Economics 43144, London School of Economics and Political Science, LSE Library.
  15. Oliver Fabel & Martin Kolmar, 2007. "On 'Golden Parachutes' as Manager Discipline," TWI Research Paper Series 17, Thurgauer Wirtschaftsinstitut, Universität Konstanz.
  16. Ohlendorf, Susanne & Schmitz, Patrick W., 2008. "Repeated Moral Hazard, Limited Liability, and Renegotiation," CEPR Discussion Papers 6725, C.E.P.R. Discussion Papers.
  17. Giat, Yahel & Subramanian, Ajay, 2013. "Dynamic contracting under imperfect public information and asymmetric beliefs," Journal of Economic Dynamics and Control, Elsevier, vol. 37(12), pages 2833-2861.
  18. Jin, Yu, 2010. "Credit Termination and the Technology Bubbles," MPRA Paper 29010, University Library of Munich, Germany.
  19. Bushman, Robert & Dai, Zhonglan & Wang, Xue, 2010. "Risk and CEO turnover," Journal of Financial Economics, Elsevier, vol. 96(3), pages 381-398, June.

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