Some Unpleasant General Equilibrium Implications of Executive Incentive Compensation Contracts
AbstractWe consider a simple variant of the standard real business cycle model in which shareholders hire a self-interested executive to manage the firm on their behalf. Delegation gives rise to a generic conflict of interest mediated by a convex (option-like) compensation contract which is able to align the interests of managers and their shareholders. With such a compensation contract, a given increase in the firm's output generated by an additional unit of physical investment results in a more than proportional increase in the manager's income. We find that incentive contracts of this form can easily result in an indeterminate general equilibrium, with business cycles driven by self-fulfilling fluctuations in the manager's expectations. These expectations are unrelated to fundamentals. Arbitrarily large fluctuations in macroeconomic variables may possibly result.
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Bibliographic InfoPaper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 15165.
Date of creation: Jul 2009
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Note: EFG ME
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Other versions of this item:
- Donaldson, John B. & Gershun, Natalia & Giannoni, Marc P., 2013. "Some unpleasant general equilibrium implications of executive incentive compensation contracts," Journal of Economic Theory, Elsevier, vol. 148(1), pages 31-63.
- E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
- J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods
This paper has been announced in the following NEP Reports:
- NEP-ALL-2009-07-28 (All new papers)
- NEP-BEC-2009-07-28 (Business Economics)
- NEP-CBA-2009-07-28 (Central Banking)
- NEP-CTA-2009-07-28 (Contract Theory & Applications)
- NEP-DGE-2009-07-28 (Dynamic General Equilibrium)
- NEP-MAC-2009-07-28 (Macroeconomics)
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