Contracting on the Stock Price and Forward-Looking Performance Measures

Posted: 14 Jan 2007

See all articles by Shane S. Dikolli

Shane S. Dikolli

Darden School of Business University of Virginia

Igor Vaysman

CUNY Baruch College, Zicklin School of Business

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Abstract

We examine the use of earnings, forward-looking performance measures and stock prices in managerial compensation. When the firm's owner and its manager have identical time preferences, the stock price is not useful for motivating the manager, as it is a noisy aggregation of a forward-looking measure and future earnings. In contrast, when the owner and the manager have conflicting time preferences, the noisy stock price is useful for contracting. If the manager has no access to banking and cannot trade the firm's shares, the timeliness of the stock price dominates the extra risk imposed by its noise. At the same time, forward-looking performance measures (such as customer satisfaction) can induce a desirable allocation of management effort between the short-term and long-term more efficiently than the stock price can. Forward-looking performance measures and the stock price are thus not direct substitutes in rewarding farsighted effort.

Keywords: Incentive pay, non-financial performance measures, Agency theory, Forward-looking performance measures, contractible performance measures, stock-based compensation

JEL Classification: J33, M41

Suggested Citation

Dikolli, Shane Sami and Vaysman, Igor, Contracting on the Stock Price and Forward-Looking Performance Measures. European Accounting Review, Vol. 15, No. 4, pp. 445-464, 2006. Available at SSRN: https://ssrn.com/abstract=956893

Shane Sami Dikolli (Contact Author)

Darden School of Business University of Virginia ( email )

P.O. Box 6550
Charlottesville, VA 22906-6550
United States
4342431018 (Phone)

Igor Vaysman

CUNY Baruch College, Zicklin School of Business ( email )

One Bernard Baruch Way, Box B12-225
New York, NY 10010
United States
646-312-3207 (Phone)

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