Abstract

http://ssrn.com/abstract=1978905
 
 

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Some Unpleasant General Equilibrium Implications of Executive Incentive Compensation Contracts


John B. Donaldson


Columbia Business School - Finance and Economics

Natalia Gershun


Pace University - Lubin School of Business

Marc P. Giannoni


Federal Reserve Bank of New York; Columbia Business School - Finance and Economics; National Bureau of Economic Research (NBER); Center for Economic Policy Research (CEPR)

December 1, 2011

FRB of New York Staff Report No. 531

Abstract:     
We consider a simple variant of the standard real business cycle model in which shareholders hire a self-interested executive to manage the firm on their behalf. A generic family of compensation contracts similar to those employed in practice is studied. When compensation is convex in the firm’s own dividend (or share price), a given increase in the firm’s output generated by an additional unit of physical investment results in a more than proportional increase in the manager’s income. Incentive contracts of sufficient yet modest convexity are shown to result in an indeterminate general equilibrium, one in which business cycles are driven by self-fulfilling fluctuations in the manager’s expectations that are unrelated to the economy’s fundamentals. Arbitrarily large fluctuations in macroeconomic variables may result. We also provide a theoretical justification for the proposed family of contracts by demonstrating that they yield first-best outcomes for specific parameter choices.

Number of Pages in PDF File: 58

Keywords: executive compensation, delegation, indeterminacy and instability

JEL Classification: E32, J33

working papers series


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Date posted: January 3, 2012  

Suggested Citation

Donaldson, John B. and Gershun, Natalia and Giannoni, Marc P., Some Unpleasant General Equilibrium Implications of Executive Incentive Compensation Contracts (December 1, 2011). FRB of New York Staff Report No. 531. Available at SSRN: http://ssrn.com/abstract=1978905 or http://dx.doi.org/10.2139/ssrn.1978905

Contact Information

John B. Donaldson
Columbia Business School - Finance and Economics ( email )
3022 Broadway
New York, NY 10027
United States

Natalia Gershun
Pace University - Lubin School of Business ( email )
1 Pace Plaza
New York, NY 10038-1502
United States
1-(212) 618-6515 (Phone)
Marc P. Giannoni (Contact Author)
Federal Reserve Bank of New York ( email )
33 Liberty Street
New York, NY 10045
United States
212-720-6935 (Phone)
HOME PAGE: http://nyfedeconomists.org/giannoni/
Columbia Business School - Finance and Economics ( email )
3022 Broadway
New York, NY 10027
United States
(212) 854-5553 (Phone)
HOME PAGE: http://www.columbia.edu/~mg2190
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Center for Economic Policy Research (CEPR)
90-98 Goswell Road
London, EC1V 7RR
United Kingdom
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