Contracting on Information about Value

Abstract

We revisit the optimal use of information under moral hazard by assuming that the agent chooses distributions nonparametrically at a cost that is increasing in the number of variables he controls. Under this assumption, the optimal contract behaves as if the principal were making inferences about outcomes she values. Consequently, Holmström's (1979) informativeness principle does not apply. A signal is useful for contracting if and only if it is informative about value, not the agent's action. This result suggests that executive compensation contracts should be based on measures of shareholder value, consistent with how CEO incentives are driven primarily by stock price.