How should performance signals affect contracts?
Journal
Review of Financial Studies
Subject
Finance
Publishing details
Authors / Editors
Chaigneau P;Edmans A;Gottlieb D
Biographies
Publication Year
2021
Abstract
The informativeness principle demonstrates that a contract should depend on informative signals. This paper studies how it should do so. Signals that indicate the output distribution has shifted to the left (e.g. weak industry performance) reduce the threshold for the manager to be paid; those that indicate output is a precise measure of effort (e.g. low volatility) decrease high thresholds and increase low thresholds. Surprisingly, "good" signals of performance need not reduce the threshold. Applying our model to performance-based vesting, we show that performance measures should affect the strike price rather than the number of vesting, contrary to practice.
Available on ECCH
No