Stock Market Tournament

44 Pages Posted: 15 Mar 2012

See all articles by Emre Ozdenoren

Emre Ozdenoren

London Business School; Centre for Economic Policy Research (CEPR)

Kathy Yuan

London School of Economics & Political Science (LSE) - Department of Finance

Date Written: March 13, 2012

Abstract

We study an optimal contracting problem between shareholders and managers when managers’ effort choices are hidden but on which stock market prices reveal some information. When the stock market rewards winners and punishes losers within an industry, stock-based incentive generates a tournament effect and causes strategic complementarity among managers of different firms in exerting effort. In the presence of this complementarity in managerial efforts, shareholders fail to internalize the impact of incentive provision to their own manager on the average industry effort level. They over (under) incentivise managers, leading managers to exert too much (little) effort, exposing shareholders to excessive (insufficient) systematic risk relative to the second best (and even the first best) during the boom (bust).

Keywords: Optimal Contract, Stock Market Tournament, Beauty Contest, Excess (Insufficient) Effort, Excessive (Insufficient) Systematic Risk-taking, Boom and Bust, Financial Crisis

JEL Classification: D86, G01, G30

Suggested Citation

Ozdenoren, Emre and Yuan, Kathy Zhichao, Stock Market Tournament (March 13, 2012). Available at SSRN: https://ssrn.com/abstract=2022544 or http://dx.doi.org/10.2139/ssrn.2022544

Emre Ozdenoren

London Business School ( email )

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

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Kathy Zhichao Yuan (Contact Author)

London School of Economics & Political Science (LSE) - Department of Finance ( email )

Old Building
Houghton Street
London, London WC2A 2AE
United Kingdom
+44 (0)20 7955 6407 (Phone)
+44 (0)20 7849 4647 (Fax)

HOME PAGE: http://fmg.lse.ac.uk/~kathy

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