A Primer on Tractable Incentive Contracts

8 Pages Posted: 24 Jun 2011 Last revised: 7 Dec 2011

See all articles by Alex Edmans

Alex Edmans

London Business School - Institute of Finance and Accounting; European Corporate Governance Institute (ECGI); Centre for Economic Policy Research (CEPR)

Xavier Gabaix

Harvard University - Department of Economics; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)

Date Written: June 23, 2011

Abstract

This note is a brief, non-technical summary of a framework that delivers tractable incentive contracts in broad settings that require few restrictions on the utility function, cost function and noise distribution, and are achievable in discrete time. The framework was developed in Edmans and Gabaix (2011). The note also contains two specific applications to (i) a market equilibrium model of CEO assignment and compensation under heterogenous moral hazard and risk aversion, and (ii) a fully dynamic model of CEO compensation where the manager consumes in every period, may temporarily inflate earnings, and may undo the contract by privately saving.

Keywords: Contract theory, executive compensation, incentives, principal-agent problem, closed forms, multiperiod contracts

JEL Classification: D2, D3, G34, J3

Suggested Citation

Edmans, Alex and Gabaix, Xavier, A Primer on Tractable Incentive Contracts (June 23, 2011). Available at SSRN: https://ssrn.com/abstract=1871218 or http://dx.doi.org/10.2139/ssrn.1871218

Alex Edmans (Contact Author)

London Business School - Institute of Finance and Accounting ( email )

Sussex Place
Regent's Park
London NW1 4SA
United Kingdom

European Corporate Governance Institute (ECGI) ( email )

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Xavier Gabaix

Harvard University - Department of Economics ( email )

Littauer Center
Cambridge, MA 02138
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR)

London
United Kingdom

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

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