Information-Based Stock Trading, Executive Incentives, and the Principal-Agent Problem

Management Science, Forthcoming

36 Pages Posted: 15 Mar 2006 Last revised: 10 Mar 2010

See all articles by Qiang Kang

Qiang Kang

Florida International University (FIU) - Department of Finance

Qiao Liu

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

Date Written: November 1, 2009

Abstract

We examine the role of information-based stock trading in affecting the risk-incentive relation. By incorporating an endogenous informed trading into an optimal incentive contracting model, we analytically show that, apart from reducing incentives, a greater risk increases the level of information-based trading which consequently enhances executive incentives and offsets the negative risk-incentive relation. We calibrate the model and find that the economic magnitude of this incentive-enhancement effect is significant. Our empirical test using real-world executive compensation data lends strong support to the model prediction. Our results suggest that principals (boards of directors) should consider underlying stock trading characteristics when structuring executive incentives.

Keywords: Risk-incentive tradeoff, endogenous information-based trading, pay-performance sensitivity, adjusted PIN, calibration

JEL Classification: D80, G14, G30, J33

Suggested Citation

Kang, Qiang and Liu, Qiao, Information-Based Stock Trading, Executive Incentives, and the Principal-Agent Problem (November 1, 2009). Management Science, Forthcoming, Available at SSRN: https://ssrn.com/abstract=890828

Qiang Kang (Contact Author)

Florida International University (FIU) - Department of Finance ( email )

University Park
11200 SW 8th Street
Miami, FL 33199
United States

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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