Reward for Luck in a Dynamic Agency Model

Review of Financial Studies, Vol. 23, No. 9, pp. 3329-3345

Posted: 2 Oct 2008 Last revised: 13 Feb 2011

See all articles by Florian Hoffmann

Florian Hoffmann

University of Bonn

Sebastian Pfeil

Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE); Erasmus Research Institute of Management (ERIM)

Date Written: February 16, 2010

Abstract

This article studies a continuous time principal-agent problem of a firm whose cash flows are determined by the manager's unobserved effort. The firm's cash flows are further subject to persistent and publicly observable shocks that are beyond the manager's control. While standard contracting models predict that compensation should optimally filter out these shocks, empirical evidence suggests otherwise. In line with this evidence, our model predicts that the manager is “rewarded for luck.”

Keywords: continuous time contracting, executive compensation

JEL Classification: G32, D82, J33

Suggested Citation

Hoffmann, Florian and Pfeil, Sebastian, Reward for Luck in a Dynamic Agency Model (February 16, 2010). Review of Financial Studies, Vol. 23, No. 9, pp. 3329-3345. Available at SSRN: https://ssrn.com/abstract=1275534

Florian Hoffmann (Contact Author)

University of Bonn ( email )

Adenauerallee 24-42
Bonn, 53113
Germany

Sebastian Pfeil

Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE) ( email )

P.O. Box 1738
3000 DR Rotterdam, NL 3062 PA
Netherlands

Erasmus Research Institute of Management (ERIM) ( email )

P.O. Box 1738
3000 DR Rotterdam
Netherlands

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