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On the Value of Improved Informativeness

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  • Pierre Chaigneau
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    Abstract

    One of the main predictions of principal-agent theory, the “informativeness principle”, is often violated in practice. We propose an explanation that emphasizes the role played by the change in the form of the optimal contract that follows an improvement in informativeness. We show that the overall gains from a less noisy performance measure emanate from two sources: the direct effect of a change in the volatility of the performance measure, and the effect of the induced change on the form of the optimal compensation contract. We emphasize that the direct effect can either largely under-estimate or largely overtimate the overall gains from improved informativeness, and we show that these gains can even be nil in some instances.

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    File URL: http://www.cirpee.org/fileadmin/documents/Cahiers_2012/CIRPEE12-05.pdf
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    Bibliographic Info

    Paper provided by CIRPEE in its series Cahiers de recherche with number 1205.

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    Date of creation: 2012
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    Handle: RePEc:lvl:lacicr:1205

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    Related research

    Keywords: Executive compensation; pay-for-luck; principal-agent model; relative performance evaluation; stock-options;

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    1. Grossman, Sanford J & Hart, Oliver D, 1983. "An Analysis of the Principal-Agent Problem," Econometrica, Econometric Society, vol. 51(1), pages 7-45, January.
    2. Oyer, Paul, 2001. "Why Do Firms Use Incentives That Have No Incentive Effects?," Research Papers 1686, Stanford University, Graduate School of Business.
    3. Ingolf Dittmann & Ernst Maug, 2007. "Lower Salaries and No Options? On the Optimal Structure of Executive Pay," Journal of Finance, American Finance Association, vol. 62(1), pages 303-343, 02.
    4. Patrick Bolton & Mathias Dewatripont, 2005. "Contract Theory," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262025760, December.
    5. Marianne Bertrand & Sendhil Mullainathan, 2001. "Are Ceos Rewarded For Luck? The Ones Without Principals Are," The Quarterly Journal of Economics, MIT Press, vol. 116(3), pages 901-932, August.
    6. Mathias Dewatripont & Patrick Legros & Steven A. Matthews, 2003. "Moral Hazard and Capital Structure Dynamics," PIER Working Paper Archive 03-006, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
    7. Garvey, Gerald T. & Milbourn, Todd T., 2006. "Asymmetric benchmarking in compensation: Executives are rewarded for good luck but not penalized for bad," Journal of Financial Economics, Elsevier, vol. 82(1), pages 197-225, October.
    8. Innes, Robert D., 1990. "Limited liability and incentive contracting with ex-ante action choices," Journal of Economic Theory, Elsevier, vol. 52(1), pages 45-67, October.
    9. Ulf Axelson & Sandeep Baliga, 2009. "Liquidity and Manipulation of Executive Compensation Schemes," Review of Financial Studies, Society for Financial Studies, vol. 22(10), pages 3907-3939, October.
    10. Maug, Ernst & Dittmann, Ingolf, 2007. "Lower Salaries and No Options: The Optimal Structure of Executive Pay," Sonderforschungsbereich 504 Publications 07-41, Sonderforschungsbereich 504, Universität Mannheim & Sonderforschungsbereich 504, University of Mannheim.
    11. Steven Shavell, 1979. "Risk Sharing and Incentives in the Principal and Agent Relationship," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 55-73, Spring.
    12. Bengt Holmstrom, 1997. "Moral Hazard and Observability," Levine's Working Paper Archive 1205, David K. Levine.
    13. Paul Oyer & Scott Schaefer, 2004. "Why Do Some Firms Give Stock Options to All Employees?: An Empirical Examination of Alternative Theories," NBER Working Papers 10222, National Bureau of Economic Research, Inc.
    14. Core, John E. & Guay, Wayne R., 2001. "Stock option plans for non-executive employees," Journal of Financial Economics, Elsevier, vol. 61(2), pages 253-287, August.
    15. Hall, Brian J. & Murphy, Kevin J., 2002. "Stock options for undiversified executives," Journal of Accounting and Economics, Elsevier, vol. 33(1), pages 3-42, February.
    16. Gjesdal, Froystein, 1982. "Information and Incentives: The Agency Information Problem," Review of Economic Studies, Wiley Blackwell, vol. 49(3), pages 373-90, July.
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