Contractual Managerial Incentives with Stock Price Feedback

We study the effect of financial market frictions on managerial compensation. We embed a market microstructure model into an otherwise standard contracting framework, and analyze optimal pay-for-performance when managers use information they learn from the market in their investment decisions. In a less frictional market, the improved information content of stock prices helps guide managerial decisions and thereby necessitates lower-powered compensation. Exploiting a randomized experiment, we document evidence that pay-for-performance is lowered in response to reduced market frictions. Firm investment also becomes more sensitive to stock prices during the experiment, consistent with increased managerial learning from the market.

Keywords: Feedback effect, CEO compensation, Financial market frictions, Reg-SHO Pilot program, Managerial learning from the market

JEL Classification: G30, J33

Suggested Citation: Suggested Citation

Lin, Tse-Chun and Liu, Qi and Sun, Bo, Contractual Managerial Incentives with Stock Price Feedback (October 30, 2018). American Economic Review (Forthcoming), Available at SSRN: https://ssrn.com/abstract=2995087 or http://dx.doi.org/10.2139/ssrn.2995087