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Debt, Managerial Incentives and Learning

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  • Neelam Jain

    (Jones Graduate School of Management, Rice University, Houston)

Abstract

Using a dynamic model with uncertainty and asymmetric information, we study the impact of debt on managerial compensation and performance targets. In this model, compensation has two roles to play – providing incentives to the manager and learning about his type. We show that debt acts as a substitute of compensation in both dimensions. If uncertainty is not too low, the incentive role of debt dominates the learning role. Thus in the presence of debt, compensation contracts can be more effective in learning about the manager. As debt increases, the pay-performance sensitivity falls and learning increases. We also examine the choice of debt and derive conditions under which a positive level of debt is optimal. We also conduct comparative statistics with respect to the degree of asymmetric information and uncertainty.

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File URL: http://www.econ.ku.dk/english/research/publications/wp/2002/0203.pdf/
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Bibliographic Info

Paper provided by University of Copenhagen. Department of Economics in its series Discussion Papers with number 02-03.

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Length: 33 pages
Date of creation: Feb 2002
Date of revision:
Handle: RePEc:kud:kuiedp:0203

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  1. Brander, J.A. & Poitevin, M., 1988. "Managerial Compensation and the Agency Costs of Debt Finance," Cahiers de recherche 8827, Universite de Montreal, Departement de sciences economiques.
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