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Some unpleasant general equilibrium implications of executive incentive compensation contracts

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  • Donaldson, John B.
  • Gershun, Natalia
  • Giannoni, Marc P.

Abstract

We consider a simple real business cycle model in which shareholders hire self-interested executives to manage their firm. A generic family of compensation contracts similar to those employed in practice is studied. When compensation is convex in the firmʼs dividend, an increase in the firmʼs output results in a more than proportional increase in the managersʼ income. Incentive contracts of sufficient yet modest convexity are shown to result in an indeterminate general equilibrium, one in which business cycles are driven by self-fulfilling fluctuations in managersʼ expectations. The proposed family of contracts may yield first-best outcomes for specific parameter choices.

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  • Donaldson, John B. & Gershun, Natalia & Giannoni, Marc P., 2013. "Some unpleasant general equilibrium implications of executive incentive compensation contracts," Journal of Economic Theory, Elsevier, vol. 148(1), pages 31-63.
    • Handle: RePEc:eee:jetheo:v:148:y:2013:i:1:p:31-63
    DOI: 10.1016/j.jet.2012.09.007
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    1. Nicola: don't forget the day job!
      by Brian Ashcroft in Scottish Economy Watch on 2012-09-06 21:13:31

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    Cited by:

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    2. Derviz, Alexis, 2013. "Bubbles, bank credit and macroprudential policies," Working Paper Series 1551, European Central Bank.
    3. Alexis Derviz, 2011. "Financial Frictions, Bubbles, and Macroprudential Policies," Working Papers 2011/04, Czech National Bank.
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    6. Alexis Derviz, 2011. "Real Implications of Bursting Asset Price Bubbles in Economies with Bank Credit," Czech Journal of Economics and Finance (Finance a uver), Charles University Prague, Faculty of Social Sciences, vol. 61(1), pages 92-116, January.

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    More about this item

    Keywords

    Delegation; Executive compensation; Indeterminacy and instability;
    All these keywords.

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods

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