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Contracting with Feedback

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  • Tse-chun Lin
  • Qi Liu

    ()

  • Bo Sun

Abstract

We study the effect of financial market conditions on managerial compensation structure. First, we analyze the optimal pay-for-performance in a model in which corporate decisions and firm value are both endogenous to trading due to feedback from information contained in stock prices. In a less frictional financial market, the improved information content of stock prices helps guide managerial decisions, and this information substitutes out part of the direct incentive provision from compensation contracts. Thus, the optimal pay-for-performance is lowered in response to reductions in market frictions. Second, we test our theory using two quasi-natural experiments and find evidence that is consistent with the theory. Our results indicate that the financial market environment plays an important role in shaping CEO compensation structure.

Suggested Citation

  • Tse-chun Lin & Qi Liu & Bo Sun, 2015. "Contracting with Feedback," International Finance Discussion Papers 1143, Board of Governors of the Federal Reserve System (U.S.).
    • Handle: RePEc:fip:fedgif:1143
    DOI: 10.17016/IFDP.2015.1143
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    Cited by:

    1. Eduardo Dávila & Cecilia Parlatore, 2019. "Trading Costs and Informational Efficiency," NBER Working Papers 25662, National Bureau of Economic Research, Inc.

    More about this item

    Keywords

    Feedback effect; CEO compensation; Transaction costs; Reg-SHO Pilot program; Decimalization;

    JEL classification:

    • G30 - Financial Economics - - Corporate Finance and Governance - - - General
    • J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods

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