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Compensation and Auditing with Correlated Information

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  • M. Martin Boyer
  • Patrick González

Abstract

An extensive academic literature exists on the optimal compensation of top executives. A less-developed literature pertains to the optimal compensation of middle management personnel. The goal of this paper is to address that concern. The setup we use is that of a firm s president (the Principal) who must distribute year end bonuses to plant managers (the Agents) who possess private information concerning production costs, information that is correlated across managers. The principal wants to design a contract that uses this correlated information. We find that the fully specified contract may be too complex for corporations to implement. This may explain why firms resort to simple schemes such as pay scales and subjective-based compensation. It gives also a theoretical bias for the existence of hierarchies in an organization. La rémunération des hauts dirigeants d entreprise a été grandement documentée. La rémunération des gestionnaires au milieu de la pyramide organisationnelle a été moins documenté toutefois. Le but de ce papier est d adresser cette lacune. Nous utilisons une approche classique de principal-multiagent où le principal doit distribuer des boni de fin d année à ses gestionnaires qui possèdent une information privilégiée en ce qui a trait aux coûts de production, une information qui est corrélée d un gestionnaire à l autre. Le principal veut structurer le contrat de manière à utiliser optimalement cette information corrélée. Nos résultats montrent qu un contrat complet peut être trop complexe à implémenter. Ceci peut expliquer pourquoi les corporations se basent très souvent sur de simple mécanismes de rémunération telles les échelles salariales. Notre étude offre également une explication pour l existence de hiérarchies dans les organisations.

Suggested Citation

  • M. Martin Boyer & Patrick González, 2001. "Compensation and Auditing with Correlated Information," CIRANO Working Papers 2001s-59, CIRANO.
  • Handle: RePEc:cir:cirwor:2001s-59
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    File URL: https://cirano.qc.ca/files/publications/2001s-59.pdf
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    References listed on IDEAS

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    1. Dilip Mookherjee & Ivan Png, 1989. "Optimal Auditing, Insurance, and Redistribution," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 104(2), pages 399-415.
    2. McAfee, R Preston & Reny, Philip J, 1992. "Correlated Information and Mechanism Design," Econometrica, Econometric Society, vol. 60(2), pages 395-421, March.
    3. M. Boyer & Patrick González, 2004. "Optimal audit policies with correlated types," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 24(2), pages 325-334, August.
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