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Optimal compensation and investment affected by firm size and time-varying external factors

Author

Listed:
  • Chong Lai

    (Curtin University)

  • Rui Li

    (University of Electronic Science and Technology of China)

  • Yonghong Wu

    (Curtin University)

Abstract

We investigate a continuous dynamic model associated with a firm size term and with an external factor term, which possesses the following peculiarities: the drift term is dominated by the principal’s investment strategy and the agent’s effort; the volatility term relies on the function $$\sqrt{G^2(t)+z_t}$$ G 2 ( t ) + z t in which $$G(t)\ge 0$$ G ( t ) ≥ 0 is a continuously bounded function and is interpreted as external factors such as external variant risks, and $$z_t$$ z t represents the firm size. The exact optimal contracts are obtained under full information. We find that the principal’s dividends in large firms are at lower risk since the flow of dividends increases with firm size. The optimal compensation scheme for the agent and investment plan for the principal are analyzed under specific assumptions. In extremely volatile environment with large G(t), the compensation for the agent would become overly large and the optimal investment is not achievable.

Suggested Citation

  • Chong Lai & Rui Li & Yonghong Wu, 2020. "Optimal compensation and investment affected by firm size and time-varying external factors," Annals of Finance, Springer, vol. 16(3), pages 407-422, September.
    • Handle: RePEc:kap:annfin:v:16:y:2020:i:3:d:10.1007_s10436-020-00365-1
    DOI: 10.1007/s10436-020-00365-1
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    References listed on IDEAS

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    More about this item

    Keywords

    Optimal contracts; Firm size; Optimal investment plan; Compensation scheme;
    All these keywords.

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods
    • M52 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Personnel Economics - - - Compensation and Compensation Methods and Their Effects

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