Contractual Managerial Incentives with Stock Price Feedback
American Economic Review (Forthcoming)
44 Pages Posted: 30 Jun 2017 Last revised: 16 Mar 2019
Date Written: October 30, 2018
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: Suggested Citation