Optimal Contract, Ownership Structure and Asset Pricing

firm continuously. We obtain a closed-form solution that characterizes the firm's ownership structure, managerial contract and equity return. As a benchmark case, we consider the first-best case with observable managerial effort in which the equilibrium solution arises solely from optimal risk sharing incentives. Through both the analytical and numerical characterizations of the model, we find that (i) The presence of moral hazard leads to a larger equity stake in the firm held by the large shareholder; (ii) Both the expected stock return and stock return volatility are lower under moral hazard because of risk sharing effects of managerial incentives; (iii) The risk aversion parameters of the manager and investors have different effects on the equilibrium outcome; (iv) The interactions among pay-performance sensitivity, large shareholder ownership, and expected stock return/stock return volatility can be positive or negative.