The Value of Performance Signals Under Limited Liability

72 Pages Posted: 29 Aug 2014 Last revised: 14 Jun 2019

See all articles by Pierre Chaigneau

Pierre Chaigneau

Queen's University

Alex Edmans

London Business School - Institute of Finance and Accounting; European Corporate Governance Institute (ECGI); Centre for Economic Policy Research (CEPR)

Daniel Gottlieb

University of Pennsylvania - Business & Public Policy Department

Multiple version iconThere are 3 versions of this paper

Date Written: May 15, 2019

Abstract

This paper studies the value of additional performance signals under limited liability. We show that -- contrary to the informativeness principle -- informative signals may have no value, because the payment cannot be adjusted to reflect the signal realization. We derive new conditions for a signal to have value under limited liability, and study how valuable signals should be incorporated into the contract. In a compensation setting, we show precisely how the signal realization should change the number of vesting options and the option strike price, providing guidance for performance-based vesting. Surprisingly, it may be optimal for more options to vest upon a negative signal of effort. In a financing setting, our results also have implications for whether the debt repayment should be performance sensitive.

Keywords: informativeness principle, limited liability, option repricing, pay-for-luck, performance-based vesting, performance-sensitive debt

JEL Classification: D86, G32, G34, J33

Suggested Citation

Chaigneau, Pierre and Edmans, Alex and Gottlieb, Daniel, The Value of Performance Signals Under Limited Liability (May 15, 2019). European Corporate Governance Institute (ECGI) - Finance Working Paper No. 439/2014. Available at SSRN: https://ssrn.com/abstract=2488144 or http://dx.doi.org/10.2139/ssrn.2488144

Pierre Chaigneau

Queen's University ( email )

Smith School of Business - Queen's University
143 Union Street
Kingston, Ontario K7L 3N6
Canada

Alex Edmans (Contact Author)

London Business School - Institute of Finance and Accounting ( email )

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

European Corporate Governance Institute (ECGI) ( email )

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Daniel Gottlieb

University of Pennsylvania - Business & Public Policy Department ( email )

3641 Locust Walk
Philadelphia, PA 19104-6372
United States

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