Risk Aversion, Performance Pay, and the Principal-Agent Problem

@article{Haubrich1994RiskAP,
  title={Risk Aversion, Performance Pay, and the Principal-Agent Problem},
  author={Joseph G. Haubrich},
  journal={Journal of Political Economy},
  year={1994},
  volume={102},
  pages={258 - 276}
}
This paper calculates numerical solutions to the principal-agent problem and compares the results to the stylized facts of CEO compensation. The numerical predictions come from parameterizing the models of Grossman and Hart and of Holmstrom and Milgrom. While the correct incentives for a CEO can greatly enhance a firm's performance, providing such incentives need not be expensive. For many parameter values, CEO compensation need increase only by about $10 for every $1,000 of additional… 
View on U Chicago Press
fraser.stlouisfed.org
361 Citations
Highly Influential Citations
20
Background Citations
124
Methods Citations
23
Results Citations
24

361 Citations

The Optimal Design of Stock Options: A Loss-aversion Approach

We analyze optimal strike prices in the context of a principal agent-model with loss aversion and calibrate the model to a cross-section of US CEOs. We …nd that for the majority of CEOs options with…

Sticks or Carrots? Optimal CEO Compensation when Managers are Loss-Averse

This paper analyzes optimal executive compensation contracts when managers are loss averse. We calibrate a stylized principal-agent model to the observed contracts of 595 CEOs and show that this…

Risk aversion, moral hazard, and the principal's loss

Summary. In their seminal paper on the principal-agent model with moral hazard, Grossman and Hart (1983) show that if the agent's utility function is $U(I,a)=-e^{-k(I-a)}$, then the loss to the…

An Empirical Analysis of the Role of Risk Aversion in Executive Compensation Contracts

This paper empirically tests the principal-agent model prediction that the use of performance measures for incentive purposes is affected by the agent’s risk aversion. We find that the use of both…

Agency Problems, Firm Valuation, and Capital Structure

This paper studies the optimal contracting problem in a general cash-�ow setup, and offers a framework to quantitatively assess the impact of agency problems. A closed form solution is obtained in…

A Parametric Curve Analysis for the Risk-Return Tradeoff in an Agency Problem

This paper proposes a simple analysis for examining an agent’s optimal decisions in a principal-agency problem. Unlike the standard approach, the target firm’s expected return and risk are modeled as…

Lower Salaries and No Options? On the Optimal Structure of Executive Pay

We estimate a standard principal agent model with constant relative risk aversion and lognormal stock prices for a sample of 598 US CEOs. The model is widely used in the compensation literature, but…

Incentives, CEO Compensation and Shareholder Wealth in a Dynamic Agency Model

M. Jensen and K. Murphy (1990,J. Polit. Econ.98, 225-264) argue that the observed pay-performance sensitivity of CEO compensation is too low to be consistent with formal agency theory. This paper…

Managerial Compensation and the Cost of Moral Hazard

This article investigates managerial compensation and its incentive effects. Our econometric framework is derived from a multiperiod principal-agent model with moral hazard. Longitudinal data on…

Linear contracts as incentives: a puzzle

This paper reexamines the linear schedule of compensation as a tool for providing incentives to managers when contractible output is a function of costly effort and a random shock. Two puzzling…
...

References

SHOWING 1-10 OF 21 REFERENCES

AN ANALYSIS OF THE PRINCIPAL-AGENT PROBLEM

Most analyses of the principal-agent problem assume that the principal chooses an incentive scheme to maximize expected utility subject to the agent’s utility being at a stationary point. An…

Incentives in Principal-Agent Relationships

This article identifies some of the major issues that have been examined in the literature on incentives. The article begins by discussing the frictions that lie at the heart of incentive problems.…

Performance Pay and Top Management Incentives

Our estimates of the pay-performance relation (including pay, options, stockholdings, and dismissal) for chief executive officers indicate that CEO wealth changes $3.25 for every $1,000 change in…

Limited liability contracts between principal and agent

AGGREGATION AND LINEARITY IN THE PROVISION OF INTERTEMPORAL INCENTIVES

The authors develop two themes in the theory of incentive schemes. First, one need not always use all of the information available in an optimal incentive contract. Accounting information, which…

Asset Returns and Intertemporal Preferences

Consumption puzzles and precautionary savings

Compensation and Incentives: Practice vs. Theory

A thorough understanding of internal incentive structures is critical to developing a viable theory of the firm, since these incentives determine to a large extent how individuals inside an…

CEO incentives-its not how much you pay, but how.

: The arrival of spring means yet another round in the national debate over executive compensation. But the critics have it wrong. The relentless attention on how much CEOs are paid diverts public…

CEO Incentives: It's Not How Much You Pay, But How

An in-depth statistical analysis of executive compensation is presented, incorporating data on thousands of CEOs spanning five decades, which concludes that with respect to pay for performance, CEO compensation is getting worse rather than better.