Optimal Incentive Contracts and Information Cascades

Review of Corporate Finance Studies 3, 123-161, 2014

Posted: 25 Aug 2014

See all articles by Praveen Kumar

Praveen Kumar

University of Houston - Department of Finance

Nisan Langberg

Tel Aviv University - Coller School of Management

Date Written: August 23, 2014

Abstract

We examine information aggregation regarding industry capital productivity from privately informed managers in a dynamic model with optimal incentive contracts. Information cascades always occur if managers enjoy limited liability: when beliefs regarding productivity become endogenously extreme (optimistic or pessimistic), learning stops. There is no learning if initial beliefs are extreme, or if agency conflicts are severe. In contrast to the literature, cascades occur even when signals have unbounded precision or when there are rich action spaces. Relaxing limited liability constraints is not sufficient to avoid cascades; we provide sufficient conditions for efficient information aggregation through incentive contracts.

JEL Classification: G32, D23

Suggested Citation

Kumar, Praveen and Langberg, Nisan, Optimal Incentive Contracts and Information Cascades (August 23, 2014). Review of Corporate Finance Studies 3, 123-161, 2014, Available at SSRN: https://ssrn.com/abstract=2485886

Praveen Kumar (Contact Author)

University of Houston - Department of Finance ( email )

Houston, TX 77204
United States
713-743-4770 (Phone)
713-743-4789 (Fax)

Nisan Langberg

Tel Aviv University - Coller School of Management ( email )

Tel Aviv
Israel

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