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Optimal compensation contracts under asymmetric information concerning expected earnings

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Author Info
Anton Miglo () (University of Guelph, Department of Economics.)

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Abstract

We analyze a model with two-dimensional asymmetric information where the employer has better information about the firm's earnings potential and the employee is subject to moral hazard. The employee's contract consists of an annual bonus and stock options. We focus on two issues: how different degrees of asymmetric information about short-term earnings versus long-term earnings affect optimal contracts and second, if a signalling equilibrium exists, what information concerning the firm's performance profile over time can be conveyed by the choice of contract. We show that if the extent of long-term (short-term) asymmetric information is larger, short-term (long-term) compensation prevails. With regard to signalling, we show that firms offering more options have higher short-term performance and lower long-term performance. This provides new insights into the structure of earnings-based compensation.

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Publisher Info
Paper provided by University of Guelph, Department of Economics in its series Working Papers with number 0613.

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Length: 22 pages
Date of creation: 2006
Date of revision:
Handle: RePEc:gue:guelph:2006-13

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Postal: Guelph, Ontario, N1G 2W1
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Related research
Keywords: Optimal compensation; Asymmetric information; Annual bonus; Stock options.;

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Find related papers by JEL classification:
D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information
J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods
M12 - Business Administration and Business Economics; Marketing; Accounting - - Business Administration - - - Personnel Management; Executive Compensation
M52 - Business Administration and Business Economics; Marketing; Accounting - - Personnel Economics - - - Compensation and Compensation Methods and Their Effects

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  1. Nachman, David C & Noe, Thomas H, 1994. "Optimal Design of Securities under Asymmetric Information," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 7(1), pages 1-44. [Downloadable!] (restricted)
  2. Brick, Ivan E & Frierman, Michael & Kim, Yu Kyung, 1998. "Asymmetric Information concerning the Variance of Cash Flows: The Capital Structure Choice," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(3), pages 745-61, August.
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    Other versions:
  5. Anton Miglo, 2006. "Debt-equity choice as a signal of earnings profile over time," Working Papers 0607, University of Guelph, Department of Economics. [Downloadable!]
    Other versions:
  6. Noldeke, Georg & van Damme, Eric, 1990. "Signalling in a Dynamic Labour Market," Review of Economic Studies, Blackwell Publishing, vol. 57(1), pages 1-23, January. [Downloadable!] (restricted)
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  7. Farmer, Roger E A, 1985. "Implicit Contracts with Asymmetric Information and Bankruptcy: The Effect of Interest Rates on Layoffs," Review of Economic Studies, Blackwell Publishing, vol. 52(3), pages 427-42, July. [Downloadable!] (restricted)
  8. Miglo, Anton & Zenkevich, Nikolay, 2005. "Non-hierarchical signalling: two-stage financing game," MPRA Paper 1264, University Library of Munich, Germany, revised 2006. [Downloadable!]
    Other versions:
  9. Jain, Bharat A & Kini, Omesh, 1994. " The Post-Issue Operating Performance of IPO Firms," Journal of Finance, American Finance Association, vol. 49(5), pages 1699-1726, December. [Downloadable!] (restricted)
  10. Chari, V V, 1983. "Involuntary Unemployment and Implicit Contracts," The Quarterly Journal of Economics, MIT Press, vol. 98(3), pages 107-22, Supplemen.
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  11. Loughran, Tim & Ritter, Jay R, 1997. " The Operating Performance of Firms Conducting Seasoned Equity Offerings," Journal of Finance, American Finance Association, vol. 52(5), pages 1823-50, December. [Downloadable!] (restricted)
  12. Azariadis, Costas, 1983. "Employment with Asymmetric Information," The Quarterly Journal of Economics, MIT Press, vol. 98(3), pages 157-72, Supplemen.
  13. Brennan, Michael J & Kraus, Alan, 1987. " Efficient Financing under Asymmetric Information," Journal of Finance, American Finance Association, vol. 42(5), pages 1225-43, December. [Downloadable!] (restricted)
  14. Lambert, Richard A., 2001. "Contracting theory and accounting," Journal of Accounting and Economics, Elsevier, vol. 32(1-3), pages 3-87, December. [Downloadable!] (restricted)
  15. Kreps, David M & Wilson, Robert, 1982. "Sequential Equilibria," Econometrica, Econometric Society, vol. 50(4), pages 863-94, July. [Downloadable!] (restricted)
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  16. Green, Jerry & Kahn, Charles M, 1983. "Wage-Employment Contracts," The Quarterly Journal of Economics, MIT Press, vol. 98(3), pages 173-87, Supplemen. [Downloadable!] (restricted)
  17. Murphy, Kevin J., 1999. "Executive compensation," Handbook of Labor Economics, in: O. Ashenfelter & D. Card (ed.), Handbook of Labor Economics, edition 1, volume 3, chapter 38, pages 2485-2563 Elsevier. [Downloadable!] (restricted)
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