Executive pay with observable decisions

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dc.contributor.author Celentani, Marco
dc.contributor.author Loveira, Rosa
dc.contributor.author Ruiz-Verdú, Pablo
dc.date.accessioned 2011-12-05T15:20:14Z
dc.date.available 2011-12-05T15:20:14Z
dc.date.issued 2010
dc.identifier.issn 1696-750X
dc.identifier.uri http://hdl.handle.net/10016/12715
dc.description.abstract We propose a model of delegated expertise designed to analyze executive compensation. An expert has to pick one of two possible decisions. By exerting effort the expert can obtain private information on these decisions. The expert’s decision and its ultimate performance realization are publicly observed, but the expert’s information is not. In other words, the principal observes the expert’s decision and its realization, but does not know whether the expert expended effort to obtain information and whether he made an efficient decision conditional on the information he received. We characterize the optimal compensation contract among those that give the expert incentives to obtain information to determine the efficient decision and to make the decision that is efficient contingent on the obtained information. We show that: 1) It is generically optimal to make pay contingent on the decision made by the expert, not only on performance; 2) The expert is often rewarded for choosing alternatives that are ex-ante inefficient. 3) When decisions differ in their complexity, optimal pay-performance may be zero if the expert chooses the complex alternative. Our model highlights novel factors that should be considered in the design of executive compensation contracts, sheds light on existing compensation practices, such as rewarding executives for acquisitions, and suggests mechanisms to promote managerial innovation.
dc.description.sponsorship We gratefully acknowledge the financial support of FEDEA and the Spanish Ministry of Innovation and Science for financial support under grant SEJ2008-03516. Rosa Loveira gratefully acknowledges the financial support of Xunta de Galicia (Spain) under the Isidro Parga Pondal research grant. We thank seminar participants at Universidad Carlos III, Universidade de Vigo, Econometric Society European Meeting 2007, 2nd European Reward Management Conference 2009, EASSET 2009, EARIE 2010 and Jornadas de Economía Industrial 2010 for useful discussions and suggestions.
dc.format.mimetype application/pdf
dc.language.iso eng
dc.publisher Fundación de Estudios de Economía Aplicada
dc.relation.ispartofseries Documentos de trabajo
dc.relation.ispartofseries 2010-29
dc.subject.other Delegated expertise
dc.subject.other Executive compensation
dc.title Executive pay with observable decisions
dc.type workingPaper
dc.subject.eciencia Empresa
dc.rights.accessRights openAccess
dc.type.version submittedVersion
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