Is An Informative Stock Price Used Less in Incentive Contracts?

Abstract

II address the way agency incentives evolve, from listed equity with low liquidity to highly liquid stocks with active informed speculators. I conclude that, as the informativeness of stock price about the manager’s actions improves, less weight needs to be given to both equity and non-price incentives due to this higher quality. Hence managerial pay-performance sensitivity should be lower in more liquid stocks but higher in illiquid start-ups and where face-to-face monitoring is impossible (franchise contracts). The model explains why firms with low inside-ownership and high liquidity increasingly dominate the U.S. market even as the total number of listings declines.

Keywords: Liquidity, Agency, Incentives, Monitoring, Franchise

JEL Classification: G34, J41, J44, L25