Stock Market Tournaments

47 Pages Posted: 28 Sep 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: June 2012

Abstract

We propose a new theory of suboptimal risk-taking based on contractual externalities. We examine an industry with a continuum of firms. Each firm's manager exerts costly hidden effort The productivity of e ffort is subject to systematic shocks. Firms' stock prices reflect their performance relative to the industry average. In this setting, stock-based incentives cause complementarities in managerial effort choices. Externalities arise because shareholders do not internalize the impact of their incentive provision on the average effort. During booms, they over-incentivise managers, triggering a rat-race in effort exertion, resulting in excessive risk relative to the second-best. The opposite occurs during busts.

Keywords: Contractual Externalities, Excessive Risk-Taking, Insuffi cient Risk-Taking, Stock-Based Incentives

JEL Classification: D86, G01, G30

Suggested Citation

Ozdenoren, Emre and Yuan, Kathy Zhichao, Stock Market Tournaments (June 2012). CEPR Discussion Paper No. DP9000, Available at SSRN: https://ssrn.com/abstract=2153432

Emre Ozdenoren (Contact Author)

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

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

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London, London WC2A 2AE
United Kingdom
+44 (0)20 7955 6407 (Phone)
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HOME PAGE: http://fmg.lse.ac.uk/~kathy

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