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Stock Market Tournaments

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  • Emre Ozdenoren
  • Kathy Yuan

Abstract

We propose a new theory of suboptimal risk-taking based on contractual externalities. We examine an industry with a continuum of _rms. Each _rm's manager exerts costly hidden e_ort. The productivity of e_ort is subject to systematic shocks. Firms' stock prices reect their performance relative to the industry average. In this setting, stock-based incentives cause complementarities in managerial e_ort choices. Externalities arise because shareholders do not internalize the impact of their incentive provision on the average e_ort. During booms, they over-incentivise managers, triggering a rat-race in e_ort exertion, resulting in excessive risk relative to the second-best. The opposite occurs during busts.

Suggested Citation

  • Emre Ozdenoren & Kathy Yuan, 2012. "Stock Market Tournaments," FMG Discussion Papers dp706, Financial Markets Group.
  • Handle: RePEc:fmg:fmgdps:dp706
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    References listed on IDEAS

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    More about this item

    JEL classification:

    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • G01 - Financial Economics - - General - - - Financial Crises
    • G30 - Financial Economics - - Corporate Finance and Governance - - - General

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