Only Time Will Tell: A Theory of Deferred Compensation

41 Pages Posted: 28 Aug 2018 Last revised: 14 Sep 2018

See all articles by Florian Hoffmann

Florian Hoffmann

University of Bonn

Roman Inderst

Goethe University Frankfurt

Marcus M. Opp

Stockholm School of Economics - Department of Finance; Swedish House of Finance

Multiple version iconThere are 2 versions of this paper

Date Written: August 9, 2018

Abstract

This paper provides a complete characterization of optimal contracts in principal-agent settings where the agent's action has persistent effects. We model general information environments via the stochastic process of the likelihood-ratio. The martingale property of this performance metric captures the information benefit of deferral. Costs of deferral may result from both the agent's relative impatience as well as her consumption smoothing needs. If the relatively impatient agent is risk neutral, optimal contracts take a simple form in that they only reward maximal performance for at most two payout dates. If the agent is additionally risk-averse, optimal contracts stipulate rewards for a larger selection of dates and performance states: The performance hurdle to obtain the same level of compensation is increasing over time whereas the pay-performance sensitivity is declining.

Keywords: Compensation design, duration of pay, moral hazard, persistence, principal- agent models, informativeness principle

JEL Classification: D86

Suggested Citation

Hoffmann, Florian and Inderst, Roman and Opp, Marcus M., Only Time Will Tell: A Theory of Deferred Compensation (August 9, 2018). SAFE Working Paper No. 218; Swedish House of Finance Research Paper No. 18-14. Available at SSRN: https://ssrn.com/abstract=3232708 or http://dx.doi.org/10.2139/ssrn.3232708

Florian Hoffmann

University of Bonn ( email )

Adenauerallee 24-42
Bonn, 53113
Germany

Roman Inderst (Contact Author)

Goethe University Frankfurt ( email )

Theodor-W.-Adorno-Platz 3
Frankfurt am Main, Hessen 60629
Germany
+49 (69) 798-34601 (Phone)
+49 (69) 798-35000 (Fax)

HOME PAGE: http://www.wiwi.uni-frankfurt.de/en/departments/finance/lehrstuhl/prof-dr-roman-inderst/team

Marcus M. Opp

Stockholm School of Economics - Department of Finance ( email )

SE-113 83 Stockholm
Sweden

Swedish House of Finance

Drottninggatan 98
111 60 Stockholm
Sweden

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