Executive Compensation and the Boundary of the Firm: The Case of Short-Lived Projects

Rodney L. White Center Working Paper No. 1-98

38 Pages Posted: 1 May 1998

See all articles by Gary B. Gorton

Gary B. Gorton

Yale School of Management; National Bureau of Economic Research (NBER); Yale University - Yale Program on Financial Stability

Bruce D. Grundy

University of Melbourne

Abstract

We consider the problem of moral hazard in the team of managers employed in a firm when the principal/firm owner can play an active role in determining team output. Unless the principal's compensation is non-decreasing in firm value there is an additional moral hazard problem since the principal will have an incentive to reduce output. In this context we determine team, and hence firm, size and solve for the form of optimal managerial compensation contracts. In particular we determine conditions under which optimal contracts will have option-like features.

JEL Classification: D2, G3, J3

Suggested Citation

Gorton, Gary B. and Grundy, Bruce D., Executive Compensation and the Boundary of the Firm: The Case of Short-Lived Projects. Rodney L. White Center Working Paper No. 1-98, Available at SSRN: https://ssrn.com/abstract=81204 or http://dx.doi.org/10.2139/ssrn.81204

Gary B. Gorton

Yale School of Management ( email )

165 Whitney Ave
P.O. Box 208200
New haven, CT 06511
United States

HOME PAGE: http://mba.yale.edu/faculty/profiles/gorton.shtml

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Yale University - Yale Program on Financial Stability

165 Whitney Avenue
P.O. Box 208200
New Haven, CT 06520-8200
United States

Bruce D. Grundy (Contact Author)

University of Melbourne ( email )

Faculty of Economics & Commerce
Department of Finance
Victoria, 3010
Australia
+61 3 8344 9083 (Phone)
+61 3 8344 6914 (Fax)

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