Optimal Share-Based Payments

29 Pages Posted: 25 Aug 2011

See all articles by Alexander Szimayer

Alexander Szimayer

University of Hamburg - Faculty of Economics and Business Administration

Date Written: August 24, 2011

Abstract

We investigate the design of optimal share-based incentive contracts by formulating a stochastic differential game between a listed company and a representative manager. The value maximizing company can grant share-based payments to the manager as incentive component of the total salary package at a premium. The manager is assumed to maximize utility from investment and consumption net of the cost for work effort. The information asymmetry is built into the model by allowing the manager to observe the level of share-based payments granted by the company. The effort exercised by the manager and her investment and consumption decision cannot be observed by the company. Accordingly we obtain a stochastic differential game of Stackelberg type. For this setting we identify a Stackelberg equilibrium that is subgame perfect Nash equilibrium by construction. Based on the equilibrium strategies we derive the optimal contract design. The results are discussed emphasizing the effect of company characteristics such as volatility and size, and manager characteristics, such as work productivity.

Keywords: principal-agent problem, share-based payments, stochastic differential game

JEL Classification: M52, C73, G11

Suggested Citation

Szimayer, Alexander, Optimal Share-Based Payments (August 24, 2011). Available at SSRN: https://ssrn.com/abstract=1916307 or http://dx.doi.org/10.2139/ssrn.1916307

Alexander Szimayer (Contact Author)

University of Hamburg - Faculty of Economics and Business Administration ( email )

Von-Melle-Park 5
Hamburg, 20146
Germany

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