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Optimal Dynamic Contract with a Shock on the Benefit of Cash Flow Diversion

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  • Vincent Tena

    (DRM - Dauphine Recherches en Management - Université Paris Dauphine-PSL - PSL - Université Paris Sciences et Lettres - CNRS - Centre National de la Recherche Scientifique)

Abstract

This paper explores a continuous-time principal-agent model where the agent can divert cash flow.The novelty is that the benefit of cash-flow diversion is subject to an exogenous and persistentshock that can be interpreted as a new regulation on the executive pay that limits the usage offringe benefits or perquisites out of the owner?s sight. First, our results suggest that the bonusesare compressed following the shock: the expected future bonuses of a good performer increasewhile those of a poor performer decrease. Second, our analysis also predicts theregulation-induced retention of a poor performer, defined as maintaining an agent in place whilehis poor performance would have induced his dismissal in the absence of the shock on the benefitof cash-flow diversion.

Suggested Citation

  • Vincent Tena, 2022. "Optimal Dynamic Contract with a Shock on the Benefit of Cash Flow Diversion," Post-Print hal-04398205, HAL.
    • Handle: RePEc:hal:journl:hal-04398205
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