Moral Hazard and the Value of Information: A Structural Approach

30 Pages Posted: 15 Dec 2022

See all articles by Jeremy Bertomeu

Jeremy Bertomeu

Washington University in St. Louis - John M. Olin Business School

Jaehoon Jung

Stanford Graduate School of Business

Ivan Marinovic

Graduate School of Business, Stanford University

Date Written: December 1, 2022

Abstract

Executive compensation contracts use information from markets and accounting to elicit efficient incentives. We structurally estimate the contribution of each performance to quantify the relative importance of price versus accounting. For plausible risk-aversion coefficients consistent with the sample, the cost of moral hazard, defined as the risk premium to be paid to elicit incentives, amounts to $4.17 million; further, in counterfactuals, we show that absent reliable accounting performance measures, average compensation increases by approximately one eighth versus more than doubling if price information is unavailable (e.g., a non-public firm). At high risk-aversion levels, dropping accounting or price information would make it infeasible to elicit high effort, with a maximal potential loss in firm value of $6.24 million without accounting and $16.13 million without price information. These results offer a first attempt to quantitatively assess the value of accounting signals in executive contracts.

Keywords: contract theory, incentive, structural estimation, performance

JEL Classification: C6, D8, M4

Suggested Citation

Bertomeu, Jeremy and Jung, Jaehoon and Marinovic, Ivan, Moral Hazard and the Value of Information: A Structural Approach (December 1, 2022). Available at SSRN: https://ssrn.com/abstract=4291189 or http://dx.doi.org/10.2139/ssrn.4291189

Jeremy Bertomeu (Contact Author)

Washington University in St. Louis - John M. Olin Business School ( email )

One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States

Jaehoon Jung

Stanford Graduate School of Business ( email )

655 Knight Way
Stanford, 94305
United States

Ivan Marinovic

Graduate School of Business, Stanford University ( email )

655 Knight Way
Stanford, CA 94305-5015
United States

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