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Optimal compensation contracts under asymmetric information concerning expected earnings

  • Anton Miglo

    ()

    (University of Guelph, Department of Economics.)

We analyze a model with two-dimensional asymmetric information where the employer has better information about the firm's earnings potential and the employee is subject to moral hazard. The employee's contract consists of an annual bonus and stock options. We focus on two issues: how different degrees of asymmetric information about short-term earnings versus long-term earnings affect optimal contracts and second, if a signalling equilibrium exists, what information concerning the firm's performance profile over time can be conveyed by the choice of contract. We show that if the extent of long-term (short-term) asymmetric information is larger, short-term (long-term) compensation prevails. With regard to signalling, we show that firms offering more options have higher short-term performance and lower long-term performance. This provides new insights into the structure of earnings-based compensation.

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Paper provided by University of Guelph, Department of Economics and Finance in its series Working Papers with number 0613.

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Length: 22 pages
Date of creation: 2006
Date of revision:
Handle: RePEc:gue:guelph:2006-13
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Web page: https://www.uoguelph.ca/economics/

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  1. van Damme, E.E.C. & Nöldeke, G., 1990. "Signaling in a dynamic labor market," Other publications TiSEM b71cd444-f4c7-4282-bcc8-a, Tilburg University, School of Economics and Management.
  2. Chari, V V, 1983. "Involuntary Unemployment and Implicit Contracts," The Quarterly Journal of Economics, MIT Press, vol. 98(3), pages 107-22, Supplemen.
  3. Farmer, Roger E A, 1985. "Implicit Contracts with Asymmetric Information and Bankruptcy: The Effect of Interest Rates on Layoffs," Review of Economic Studies, Wiley Blackwell, vol. 52(3), pages 427-42, July.
  4. Mikkelson, Wayne H. & Partch, M. Megan & Shah, Kshitij, 1997. "Ownership and operating performance of companies that go public," Journal of Financial Economics, Elsevier, vol. 44(3), pages 281-307, June.
  5. Cho, In-Koo & Kreps, David M, 1987. "Signaling Games and Stable Equilibria," The Quarterly Journal of Economics, MIT Press, vol. 102(2), pages 179-221, May.
  6. Bushman, Robert & Chen, Qi & Engel, Ellen & Smith, Abbie, 2004. "Financial accounting information, organizational complexity and corporate governance systems," Journal of Accounting and Economics, Elsevier, vol. 37(2), pages 167-201, June.
  7. Anton Miglo & Nikolay Zenkevich, 2006. "Non-hierarchical signalling: two-stage financing game," Working Papers 0603, University of Guelph, Department of Economics and Finance.
  8. Azariadis, Costas, 1983. "Employment with Asymmetric Information," The Quarterly Journal of Economics, MIT Press, vol. 98(3), pages 157-72, Supplemen.
  9. Baker, G.P. & Jensen, M.C. & Murphy, K.J., 1988. "Compensation And Incentives: Practice Vs. Theory," Papers 88-05, Rochester, Business - Managerial Economics Research Center.
  10. Green, Jerry & Kahn, Charles M, 1983. "Wage-Employment Contracts," The Quarterly Journal of Economics, MIT Press, vol. 98(3), pages 173-87, Supplemen.
  11. Jain, Bharat A & Kini, Omesh, 1994. " The Post-Issue Operating Performance of IPO Firms," Journal of Finance, American Finance Association, vol. 49(5), pages 1699-1726, December.
  12. Nachman, David C & Noe, Thomas H, 1994. "Optimal Design of Securities under Asymmetric Information," Review of Financial Studies, Society for Financial Studies, vol. 7(1), pages 1-44.
  13. Anton Miglo, 2006. "Debt-equity choice as a signal of earnings profile over time," Working Papers 0607, University of Guelph, Department of Economics and Finance.
  14. David Kreps & Robert Wilson, 1998. "Sequential Equilibria," Levine's Working Paper Archive 237, David K. Levine.
  15. Brick, Ivan E & Frierman, Michael & Kim, Yu Kyung, 1998. "Asymmetric Information concerning the Variance of Cash Flows: The Capital Structure Choice," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(3), pages 745-61, August.
  16. Lambert, Richard A., 2001. "Contracting theory and accounting," Journal of Accounting and Economics, Elsevier, vol. 32(1-3), pages 3-87, December.
  17. Loughran, Tim & Ritter, Jay R, 1997. " The Operating Performance of Firms Conducting Seasoned Equity Offerings," Journal of Finance, American Finance Association, vol. 52(5), pages 1823-50, December.
  18. Murphy, Kevin J., 1999. "Executive compensation," Handbook of Labor Economics, in: O. Ashenfelter & D. Card (ed.), Handbook of Labor Economics, edition 1, volume 3, chapter 38, pages 2485-2563 Elsevier.
  19. Albert Ma, C.T. & Weiss, A.M., 1991. "A Signaling Theory of Unemployment," Papers 7, Boston University - Department of Economics.
  20. Brennan, Michael J & Kraus, Alan, 1987. " Efficient Financing under Asymmetric Information," Journal of Finance, American Finance Association, vol. 42(5), pages 1225-43, December.
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