Value of performance signals under limited liability

Subject

Finance

Publishing details

European Corporate Governance Institute - Finance Working Paper

Authors / Editors

Chaigneau P; Edmans A; Gottlieb D

Biographies

Publication Year

2018

Abstract

This paper studies the value of additional performance signals under limited liability. We show that -- contrary to the informativeness principle -- informative signals may have no value, because the payment cannot be adjusted to reflect the signal realization. We derive necessary and sufficient conditions for a signal to have value under limited liability, and study how valuable signals should be incorporated into the contract. Our results have implications for performance-sensitive debt, pay-for-luck, option repricing, and performance-based vesting. For example, it may be optimal for more options to vest upon a negative signal of effort.

Keywords

Informativeness principle; Contract theory; Principal-agent model; Limited liability; Pay-for-luck; Relative performance evaluation; Vesting; Repricing; Options

Publication Notes

Revised Dec 16 2018

Series Number

439/2014

Series

European Corporate Governance Institute - Finance Working Paper