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Managerial compensation with hyperbolic discounting

Author

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  • Niu, Yingjie
  • He, Linfeng
  • Wu, Wei

Abstract

This paper characterizes the optimal performance-based compensation plan for alignment by incorporating time inconsistent preferences. When investment payoffs are given in flow terms, the presence of time-inconsistency enhances the fraction of the cash flows the manager should receive and delays investment. However, in the lump-sum payoff case, the smaller the time inconsistency, the higher the value-sharing bonus needed for aligning interests with the managers and the earlier the investment exercise. Furthermore, we find that the parameters describing the project value also matter for the optimal contract scheme.

Suggested Citation

  • Niu, Yingjie & He, Linfeng & Wu, Wei, 2021. "Managerial compensation with hyperbolic discounting," Finance Research Letters, Elsevier, vol. 38(C).
    • Handle: RePEc:eee:finlet:v:38:y:2021:i:c:s1544612319305446
    DOI: 10.1016/j.frl.2019.101390
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    More about this item

    Keywords

    Compensation plan; Investment threshold; Time inconsistent preferences; Lump-sum payoff; Flow payoff;
    All these keywords.

    JEL classification:

    • D90 - Microeconomics - - Micro-Based Behavioral Economics - - - General
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods

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