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Only time will tell: A theory of deferred compensation

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  • Hoffmann, Florian
  • Inderst, Roman
  • Opp, Marcus M.

Abstract

This paper provides a complete characterization of optimal contracts in principal-agent settings where the agent's action has persistent effects. We model general information environments via the stochastic process of the likelihood-ratio. The martingale property of this performance metric captures the information benefit of deferral. Costs of deferral may result from both the agent's relative impatience as well as her consumption smoothing needs. If the relatively impatient agent is risk neutral, optimal contracts take a simple form in that they only reward maximal performance for at most two payout dates. If the agent is additionally risk-averse, optimal contracts stipulate rewards for a larger selection of dates and performance states: The performance hurdle to obtain the same level of compensation is increasing over time whereas the pay-performance sensitivity is declining.

Suggested Citation

  • Hoffmann, Florian & Inderst, Roman & Opp, Marcus M., 2018. "Only time will tell: A theory of deferred compensation," SAFE Working Paper Series 218, Leibniz Institute for Financial Research SAFE.
    • Handle: RePEc:zbw:safewp:218
    DOI: 10.2139/ssrn.3232708
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    6. Stefano Colonnello & Giuliano Curatola & Shuo Xia, 2024. "When Does Linking Pay to Default Reduce Bank Risk?," Working Papers 2024: 07, Department of Economics, University of Venice "Ca' Foscari".

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    More about this item

    Keywords

    compensation design; duration of pay; moral hazard; persistence; principal-agent models; informativeness principle;
    All these keywords.

    JEL classification:

    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law

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