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When to fire a CEO: optimal termination in dynamic contracts

  • Spear, Stephen E.
  • Wang, Cheng

Existing models of dynamic contracts impose that it is both optimal and feasible for the contracting parties to bind themselves together forever. This paper introduces optimal terminatin in dynamic contracts. We modify the standard dynamic agency model to include an external labor market which, upon the dissolution of the contract, allows the firm to return to the labor market to seek a new match. Under this simple closure of the model, two types of terminations emerge. Under one scenario, the agent is fired after a sequence of bad outputs and she becomes too poor to be punished effectively. Under the second scenario, the agent is forced out after a sequence of good outputs and she becomes too expensive to motivate. We then use the model to study issues of CEO termination and firm dynamics.

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Article provided by Elsevier in its journal Journal of Economic Theory.

Volume (Year): 120 (2005)
Issue (Month): 2 (February)
Pages: 239-256

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Handle: RePEc:eee:jetheo:v:120:y:2005:i:2:p:239-256
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/622869

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  1. Spear, Stephen E & Srivastava, Sanjay, 1987. "On Repeated Moral Hazard with Discounting," Review of Economic Studies, Wiley Blackwell, vol. 54(4), pages 599-617, October.
  2. Wang, Cheng, 1997. "Incentives, CEO Compensation and Shareholder Wealth in a Dynamic Agency Model," Staff General Research Papers 5170, Iowa State University, Department of Economics.
  3. Stiglitz, Joseph E & Weiss, Andrew, 1983. "Incentive Effects of Terminations: Applications to the Credit and Labor Markets," American Economic Review, American Economic Association, vol. 73(5), pages 912-27, December.
  4. Phelan Christopher, 1995. "Repeated Moral Hazard and One-Sided Commitment," Journal of Economic Theory, Elsevier, vol. 66(2), pages 488-506, August.
  5. Shapiro, Carl & Stiglitz, Joseph E, 1984. "Equilibrium Unemployment as a Worker Discipline Device," American Economic Review, American Economic Association, vol. 74(3), pages 433-44, June.
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