Contracting on What Firm Owners Value

46 Pages Posted: 25 Aug 2021 Last revised: 4 Feb 2022

See all articles by Jonathan Bonham

Jonathan Bonham

The University of Chicago Booth School of Business

Amoray Riggs-Cragun

University of Chicago Booth School of Business

Date Written: July 24, 2021

Abstract

We revisit foundational questions in agency theory while assuming that the agent can fine-tune the joint distribution of all contractible and non-contractible performance measures. Under this assumption, optimal contracts behave as if the principal were making inferences about the outcome she values rather than about the agent's action. This has significant implications for what measures are included in contracts and how those measures are used. Most importantly, Holmström's (1979) informativeness principle changes. A performance measure is valuable if it improves inferences not about the agent's action, but about the outcome the principal values; and if that outcome is contractible, additional measures have no value. Our model predicts that contracts should be written only on outcomes that firm owners value, consistent with real-world contracts that tie executive pay to only a handful of accounting, market, or nonfinancial measures.

Suggested Citation

Bonham, Jonathan and Riggs-Cragun, Amoray, Contracting on What Firm Owners Value (July 24, 2021). Chicago Booth Research Paper No. 22-03, Available at SSRN: https://ssrn.com/abstract=3892838 or http://dx.doi.org/10.2139/ssrn.3892838

Jonathan Bonham

The University of Chicago Booth School of Business ( email )

1101 East 58th Street
Chicago, IL 60637-1561
United States
7738344748 (Phone)

HOME PAGE: http://https://www.chicagobooth.edu/faculty/directory/b/jonathan-bonham

Amoray Riggs-Cragun (Contact Author)

University of Chicago Booth School of Business ( email )

5807 S Woodlawn Ave
Chicago, IL 60637
United States

HOME PAGE: http://www.riggscragun.com/

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