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Prudence and the convexity of compensation contracts

Author

Listed:
  • Pierre Chaigneau

    (SPHERE (UMR_7219) - Sciences, Philosophie, Histoire - UPD7 - Université Paris Diderot - Paris 7 - CNRS - Centre National de la Recherche Scientifique)

  • Nicolas Sahuguet

    (HEC Montréal - HEC Montréal)

  • Bernard Sinclair-Desgagné

    (SKEMA Business School - SKEMA Business School)

Abstract

In a standard principal–agent model, we derive a new condition that relates the structure of the optimal contract to the agent’s risk preferences: The optimal contract is more convex than the likelihood ratio of the performance measure if and only if the coefficient of absolute prudence is larger than twice the coefficient of absolute risk aversion. With CRRA utility, this condition is satisfied if and only if relative risk aversion is less than one.
(This abstract was borrowed from another version of this item.)

Suggested Citation

  • Pierre Chaigneau & Nicolas Sahuguet & Bernard Sinclair-Desgagné, 2017. "Prudence and the convexity of compensation contracts," Post-Print halshs-02292785, HAL.
    • Handle: RePEc:hal:journl:halshs-02292785
    DOI: 10.1016/j.econlet.2017.05.014
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    Cited by:

    1. Pierre Chaigneau & Alex Edmans & Daniel Gottlieb, 2022. "How Should Performance Signals Affect Contracts?," The Review of Financial Studies, Society for Financial Studies, vol. 35(1), pages 168-206.
    2. Keenan, Donald C. & Snow, Arthur, 2024. "Full downside risk aversion," Mathematical Social Sciences, Elsevier, vol. 131(C), pages 93-101.

    More about this item

    JEL classification:

    • D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods

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