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Debt, Managerial Incentives and Learning

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  • Neelam Jain

    (Jones Graduate School of Management, Rice University, Houston)

Abstract

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.

Suggested Citation

  • Neelam Jain, 2002. "Debt, Managerial Incentives and Learning," Discussion Papers 02-03, University of Copenhagen. Department of Economics.
  • Handle: RePEc:kud:kuiedp:0203
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    File URL: http://www.econ.ku.dk/english/research/publications/wp/2002/0203.pdf/
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    References listed on IDEAS

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    1. 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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    More about this item

    JEL classification:

    • D8 - Microeconomics - - Information, Knowledge, and Uncertainty
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • J3 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs

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