Incentives and Performance with Optimal Money Management Contracts

46 Pages Posted: 21 Nov 2019 Last revised: 4 Nov 2021

See all articles by Stefano Pegoraro

Stefano Pegoraro

University of Notre Dame - Department of Finance

Date Written: October 29, 2021

Abstract

I characterize the dynamics of incentives in an optimal contract with investment delegation, moral hazard, and uncertainty about the agent's productivity. The principal increases the agent's incentives after good performance in order to delegate more capital to an agent with higher perceived productivity, thus implementing a convex pay-for-performance scheme. Moreover, the principal commits to reduce the agent's future incentives in order to mitigate ex-ante investment distortions. Methodologically, I provide a duality-based strategy to overcome technical challenges common to continuous-time contracting models with state variables. I also derive a sufficient condition to verify the validity of the first-order approach.

Keywords: Dynamic contracts, managerial compensation, duality, dynamic programming, delegated investment

JEL Classification: D86, D82, C73, C61, J33, M52

Suggested Citation

Pegoraro, Stefano, Incentives and Performance with Optimal Money Management Contracts (October 29, 2021). Available at SSRN: https://ssrn.com/abstract=3480765 or http://dx.doi.org/10.2139/ssrn.3480765

Stefano Pegoraro (Contact Author)

University of Notre Dame - Department of Finance ( email )

P.O. Box 399
Notre Dame, IN 46556-0399
United States
5746312240 (Phone)
46556 (Fax)

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