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A Quantitative Model of Dynamic Moral Hazard

Author

Listed:
  • Hengjie Ai
  • Dana Kiku
  • Rui Li
  • Stijn Van

Abstract

We develop an equilibrium model with moral hazard, which arises because some productivity shocks are privately observed by firm managers only. We characterize the optimal contract and its implications for firm size, growth, and managerial pay-performance sensitivity and exploit them to quantify the severity of the moral hazard problem. Our estimation suggests that unobservable shocks are relatively modest and account for about 10 of the total variation of firm output. Nonetheless, moral-hazard-induced incentive pay is quantitatively significant and accounts for 50 of managerial compensation. Eliminating moral hazard would result in about a 1 increase in aggregate output.

Suggested Citation

  • Hengjie Ai & Dana Kiku & Rui Li & Stijn Van, 2023. "A Quantitative Model of Dynamic Moral Hazard," The Review of Financial Studies, Society for Financial Studies, vol. 36(4), pages 1408-1463.
    • Handle: RePEc:oup:rfinst:v:36:y:2023:i:4:p:1408-1463.
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    File URL: http://hdl.handle.net/10.1093/rfs/hhac059
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    More about this item

    JEL classification:

    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • M12 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Business Administration - - - Personnel Management; Executives; Executive Compensation

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