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Compensation and Agency

Paper Session

Friday, Jan. 5, 2018 10:15 AM - 12:15 PM

Loews Philadelphia, Commonwealth Hall A1
Hosted By: American Finance Association
  • Chair: Felipe Varas, Duke University

The Value of Performance Signals Under Contracting Constraints

Pierre Chaigneau
Queen's University
Alex Edmans
London Business School
Daniel Gottlieb
Washington University-St. Louis


This paper studies the value of additional performance signals for compensation and financing contracts under contracting constraints, such as limited liability, monotonicity, or upper bounds to pay or incentives. We show that informative signals may have no value, because the payment cannot be adjusted to reflect the signal realization -- contrary to the informativeness principle, which was derived assuming no contracting constraints. We derive necessary and sufficient conditions for a signal to have value under such constraints, and study how valuable signals are incorporated into the contract. We discuss the implications of our results for pay-for-luck, option repricing, performance-based vesting, performance-sensitive debt, and the conditions under which a principal should invest in costly monitoring. For example, it may be optimal to lower the strike price of an option upon a negative signal of effort.

Compensation, Moral Hazard, and Talent Misallocation in the Market for CEOs

Liang Chen
Wuhan University


This paper develops a structural model to quantify the efficiency loss arising from both
risk sharing and talent misallocation due to the presence of moral hazard in the market
for CEOs. I estimate the model parameters characterizing CEOs' preferences, firm'
technologies, and their productive type distributions (firms' size and CEOs' talent)
from the data on firms' market value, financial returns and CEO compensation. The
estimation results show that more leveraged firms and/or firms with more assets tend
to end up with less-talented CEOs. By using the estimates of model parameters, I
conduct counterfactuals to show that the talent misallocation led to a loss up to USD
1.6 billion dollars for the 1000 largest US firms in 2011. This amount is almost three
times the loss arising from the risk-sharing inefficiency.

Contract Horizon and Turnover

Vladimir Vladimirov
University of Amsterdam


This paper develops a model in which a principal hires agents whose fit with the firm changes over time. Agents are better informed about such changes, so the principal must decide how to elicit information that could lead to an agent's dismissal. The paper rationalizes the use of renewable fixed-term contracts as a mechanism that periodically switches from relying on severance pay to relying on firm performance on renewal dates to sort out agents. The paper's key implications focus on the determinants of contract horizon. Furthermore, it sheds light on several puzzling stylized facts concerning hiring and replacement practices.
Ming Yang
Duke University
Robert Miller
Carnegie Mellon University
John Zhu
University of Pennsylvania
JEL Classifications
  • G3 - Corporate Finance and Governance