Some Unpleasant General Equilibrium Implications of Executive Incentive Compensation Contracts / John B. Donaldson, Natalia Gershun, Marc P. Giannoni.

Format:

Book

Author/Creator:

Donaldson, John B.

Contributor:

National Bureau of Economic Research.

Gershun, Natalia.

Giannoni, Marc P.

Series:

Working Paper Series (National Bureau of Economic Research) no. w15165.

NBER working paper series no. w15165

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2009.

Summary:

We consider a simple variant of the standard real business cycle model in which shareholders hire a self-interested executive to manage the firm on their behalf. Delegation gives rise to a generic conflict of interest mediated by a convex (option-like) compensation contract which is able to align the interests of managers and their shareholders. With such a compensation contract, a given increase in the firm's output generated by an additional unit of physical investment results in a more than proportional increase in the manager's income. We find that incentive contracts of this form can easily result in an indeterminate general equilibrium, with business cycles driven by self-fulfilling fluctuations in the manager's expectations. These expectations are unrelated to fundamentals. Arbitrarily large fluctuations in macroeconomic variables may possibly result.

Notes:

Print version record

July 2009.