Stock Trading, Information Production and Incentive Pay

40 Pages Posted: 12 Oct 2003

See all articles by Qiang Kang

Qiang Kang

The University of Hong Kong - School of Economics and Finance

Qiao Liu

The University of Hong Kong - School of Economics and Finance; Peking University - Guanghua School of Management

Date Written: October 2003

Abstract

This paper examines under what circumstances the market-based compensation scheme is effective in inducing managers' incentives. We combine the optimal contract theory with the market microstructure literature and endogenize both the optimal compensation scheme and the stock market equilibrium. We analytically show that the incentive pay works better in a more efficient (or more informative) stock market. Empirical tests justify our model prediction. Using residual analyst coverage as one proxy for market informativeness, we find that the coverage is negatively related to the compensation level and positively to the pay-for-performance sensitivity, suggesting that an efficient market induces managerial incentives as well as structures their behavior.

Keywords: Information, optimal contract, market microstructure, pay-for-performance sensitivity

JEL Classification: D80, G14, G34, J33

Suggested Citation

Kang, Qiang and Liu, Qiao, Stock Trading, Information Production and Incentive Pay (October 2003). Available at SSRN: https://ssrn.com/abstract=454540 or http://dx.doi.org/10.2139/ssrn.454540

Qiang Kang (Contact Author)

The University of Hong Kong - School of Economics and Finance ( email )

8th Floor Kennedy Town Centre
23 Belcher's Street
Kennedy Town
Hong Kong
(852)2859-1048 (Phone)
(852)2548-1152 (Fax)

Qiao Liu

The University of Hong Kong - School of Economics and Finance ( email )

School of Economics and Finance
Pokfulam
Hong Kong
Hong Kong
852-2859-1059 (Phone)
852-2548-1152 (Fax)

Peking University - Guanghua School of Management ( email )

Peking University
Beijing, Beijing 100871
China

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