Performance Evaluation, Managerial Hedging, and Contract Termination

66 Pages Posted: 4 Dec 2017 Last revised: 26 Apr 2021

See all articles by Yu Huang

Yu Huang

Shanghai Jiao Tong University (SJTU) - Shanghai Advanced Institute of Finance (SAIF)

Nengjiu Ju

Shanghai Jiao Tong University (SJTU) - Shanghai Advanced Institute of Finance (SAIF)

Hao Xing

Boston University - Questrom School of Business

Date Written: April 26, 2021

Abstract

We develop a dynamic model where a CARA principal contracts with a CARA agent to operate a firm. The agent, protected by limited liability, trades privately a market portfolio to hedge market risk in his compensation. When the liquidation cost of the firm is proportional to its size, principal manages the termination risk by loading the contract with a positive market component which alleviates termination risk in normal market conditions, but makes termination more likely after negative shocks. The optimal contract displays a dynamic mixture of absolute and relative performance evaluations, and is implemented through capital structure featuring a dynamic deferred compensation account.

Keywords: Moral Hazard, Managerial Hedging, Optimal Contracting, Performance Evaluation

JEL Classification: G11, G12, G32, D82, E2

Suggested Citation

Huang, Yu and Ju, Nengjiu and Xing, Hao, Performance Evaluation, Managerial Hedging, and Contract Termination (April 26, 2021). Available at SSRN: https://ssrn.com/abstract=3079655 or http://dx.doi.org/10.2139/ssrn.3079655

Yu Huang

Shanghai Jiao Tong University (SJTU) - Shanghai Advanced Institute of Finance (SAIF) ( email )

Shanghai Jiao Tong University
211 West Huaihai Road
Shanghai, 200030
China

Nengjiu Ju (Contact Author)

Shanghai Jiao Tong University (SJTU) - Shanghai Advanced Institute of Finance (SAIF) ( email )

Shanghai Jiao Tong University
211 West Huaihai Road
Shanghai, 200030
China

Hao Xing

Boston University - Questrom School of Business ( email )

595 Commonwealth Avenue
Boston, MA MA 02215
United States

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