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Stock Market Tournaments

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  • Ozdenoren, Emre
  • Yuan, Kathy

Abstract

We propose a new theory of suboptimal risk-taking based on contractual externalities. We examine an industry with a continuum of firms. Each firm's manager exerts costly hidden effort The productivity of e ffort is subject to systematic shocks. Firms' stock prices reflect their performance relative to the industry average. In this setting, stock-based incentives cause complementarities in managerial effort choices. Externalities arise because shareholders do not internalize the impact of their incentive provision on the average effort. During booms, they over-incentivise managers, triggering a rat-race in effort exertion, resulting in excessive risk relative to the second-best. The opposite occurs during busts.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 9000.

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Date of creation: Jun 2012
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Handle: RePEc:cpr:ceprdp:9000

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Keywords: Contractual Externalities; Excessive Risk-Taking; Insufficient Risk-Taking; Stock-Based Incentives;

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