Debt, Managerial Incentives and Learning
Using a dynamic model with uncertainty and asymmetric information, we study the impact of debt on managerial compensation and performance targets. In this model, compensation has two roles to play – providing incentives to the manager and learning about his type. We show that debt acts as a substitute of compensation in both dimensions. If uncertainty is not too low, the incentive role of debt dominates the learning role. Thus in the presence of debt, compensation contracts can be more effective in learning about the manager. As debt increases, the pay-performance sensitivity falls and learning increases. We also examine the choice of debt and derive conditions under which a positive level of debt is optimal. We also conduct comparative statistics with respect to the degree of asymmetric information and uncertainty.
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- Brander, J.A. & Poitevin, M., 1988.
"Managerial Compensation and the Agency Costs of Debt Finance,"
Cahiers de recherche
8827, Universite de Montreal, Departement de sciences economiques.
- Brander, J.A. & Poitevin, M., 1988. "Managerial Compensation And The Agency Costs Of Debt Finance," Cahiers de recherche 8827, Centre interuniversitaire de recherche en économie quantitative, CIREQ.
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