A Primer on Tractable Incentive Contracts
8 Pages Posted: 24 Jun 2011 Last revised: 7 Dec 2011
Date Written: June 23, 2011
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: Suggested Citation