Contractual Managerial Incentives with Stock Price Feedback

American Economic Review (Forthcoming)

44 Pages Posted: 30 Jun 2017 Last revised: 16 Mar 2019

See all articles by Tse-Chun Lin

Tse-Chun Lin

The University of Hong Kong - Faculty of Business and Economics

Qi Liu

Peking University - Department of Finance

Bo Sun

Board of Governors of the Federal Reserve System - Division of International Finance

Multiple version iconThere are 2 versions of this paper

Date Written: October 30, 2018

Abstract

We study the effect of financial market frictions on managerial compensation. We embed a market microstructure model into an otherwise standard contracting framework, and analyze optimal pay-for-performance when managers use information they learn from the market in their investment decisions. In a less frictional market, the improved information content of stock prices helps guide managerial decisions and thereby necessitates lower-powered compensation. Exploiting a randomized experiment, we document evidence that pay-for-performance is lowered in response to reduced market frictions. Firm investment also becomes more sensitive to stock prices during the experiment, consistent with increased managerial learning from the market.

Keywords: Feedback effect, CEO compensation, Financial market frictions, Reg-SHO Pilot program, Managerial learning from the market

JEL Classification: G30, J33

Suggested Citation

Lin, Tse-Chun and Liu, Qi and Sun, Bo, Contractual Managerial Incentives with Stock Price Feedback (October 30, 2018). American Economic Review (Forthcoming). Available at SSRN: https://ssrn.com/abstract=2995087 or http://dx.doi.org/10.2139/ssrn.2995087

Tse-Chun Lin

The University of Hong Kong - Faculty of Business and Economics ( email )

Pokfulam Road
Hong Kong
China

Qi Liu

Peking University - Department of Finance ( email )

Beijing
China

Bo Sun (Contact Author)

Board of Governors of the Federal Reserve System - Division of International Finance ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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