How should performance signals affect contracts?

Chaigneau, Pierre, Edmans, Alex and Gottlieb, Daniel ORCID: 0000-0002-0555-6185 (2022) How should performance signals affect contracts? Review of Financial Studies, 35 (1). 168 - 206. ISSN 0893-9454

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Abstract

The informativeness principle states that a contract should depend on informative signals. This paper studies how it should do so. Signals indicating that the output distribution has shifted to the left (e.g., weak industry performance) reduce the threshold for the manager to be paid; those indicating that 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 options, contrary to practice.

Item Type:	Article
Official URL:	https://academic.oup.com/rfs
Additional Information:	© 2021 The Authors
Divisions:	Management
Subjects:	H Social Sciences > HD Industries. Land use. Labor
JEL classification:	D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D86 - Economics of Contract: Theory G - Financial Economics > G3 - Corporate Finance and Governance > G34 - Mergers; Acquisitions; Restructuring; Corporate Governance G - Financial Economics > G3 - Corporate Finance and Governance > G32 - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure J - Labor and Demographic Economics > J3 - Wages, Compensation, and Labor Costs > J33 - Compensation Packages; Payment Methods
Date Deposited:	13 Mar 2021 00:30
Last Modified:	07 Apr 2024 07:21
URI:	http://eprints.lse.ac.uk/id/eprint/109005

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