Tractability in Incentive Contracting
AbstractThis article develops a framework that delivers tractable (i.e., closed-form) optimal contracts, with few restrictions on the utility function, cost of effort, or noise distribution. By modeling the noise before the action in each period, we force the contract to provide correct incentives state-by-state, rather than merely on average. This tightly constrains the set of admissible contracts and allows for a simple solution to the contracting problem. Our results continue to hold in continuous time, where noise and actions are simultaneous. We illustrate the potential usefulness of our setup by a series of examples related to CEO incentives. In particular, the model derives predictions for the optimal measure of incentives and whether the contract should be convex, concave, or linear. The Author 2011. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: firstname.lastname@example.org., Oxford University Press.
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Bibliographic InfoArticle provided by Society for Financial Studies in its journal Review of Financial Studies.
Volume (Year): 24 (2011)
Issue (Month): 9 ()
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Other versions of this item:
- Alex Edmans & Xavier Gabaix, 2009. "Tractability in Incentive Contracting," NBER Working Papers 15545, National Bureau of Economic Research, Inc.
- Edmans, Alex & Gabaix, Xavier, 2009. "Tractability in Incentive Contracting," CEPR Discussion Papers 7578, C.E.P.R. Discussion Papers.
- Xavier Gabaix & Alex Edmans, 2010. "Tractability in Incentive Contracting," 2010 Meeting Papers 1120, Society for Economic Dynamics.
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7836, C.E.P.R. Discussion Papers.
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- Laux, Volker, 2012. "Stock option vesting conditions, CEO turnover, and myopic investment," Journal of Financial Economics, Elsevier, vol. 106(3), pages 513-526.
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