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Stock Market Tournaments

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  • Yuan, Kathy
  • Ozdenoren, Emre

Abstract

We propose a new theory of suboptimal risk-taking based on contractual externalities. We examine an industry with a continuum of firms. Each firm's manager exerts costly hidden effort The productivity of e ffort is subject to systematic shocks. Firms' stock prices reflect their performance relative to the industry average. In this setting, stock-based incentives cause complementarities in managerial effort choices. Externalities arise because shareholders do not internalize the impact of their incentive provision on the average effort. During booms, they over-incentivise managers, triggering a rat-race in effort exertion, resulting in excessive risk relative to the second-best. The opposite occurs during busts.

Suggested Citation

  • Yuan, Kathy & Ozdenoren, Emre, 2012. "Stock Market Tournaments," CEPR Discussion Papers 9000, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:9000
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    More about this item

    Keywords

    Contractual externalities; Excessive risk-taking; Insufficient risk-taking; Stock-based incentives;
    All these keywords.

    JEL classification:

    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • G01 - Financial Economics - - General - - - Financial Crises
    • G30 - Financial Economics - - Corporate Finance and Governance - - - General

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