nep-cta New Economics Papers
on Contract Theory and Applications
Issue of 2008‒04‒04
five papers chosen by
Simona Fabrizi
Massey University Department of Commerce

  1. A Theory of Liquidity and Regulation of Financial Intermediation By Emmanuel Farhi; Mikhail Golosov; Aleh Tsyvinski
  2. The theory of implementation : what did we learn? By Luis C. Corchon
  3. General equilibrium with private state verification By João Correia-da-Silva; Carlos Hervés-Belo
  4. Executive Stock Options when Managers are Loss-Averse By Dittmann, Ingolf; Maug, Ernst; Spalt, Oliver
  5. Lower Salaries and No Options: The Optimal Structure of Executive Pay By Maug, Ernst; Dittmann, Ingolf

  1. By: Emmanuel Farhi; Mikhail Golosov; Aleh Tsyvinski
    Date: 2008–03–21
  2. By: Luis C. Corchon
    Date: 2007–12
  3. By: João Correia-da-Silva (CEMPRE and Faculdade de Economia, Universidade do Porto, Portugal); Carlos Hervés-Belo (RGEA and Facultad de Económicas, Universidad de Vigo, Spain)
    Abstract: We study general equilibrium with private and incomplete state verification. Trade is agreed ex ante, that is, before private information is received. It is useful to define a list of bundles as a derivative good that gives an agent the right to receive one of the bundles in the list. Enforceable trade agreements can be described by Pi-measurable plans of lists of bundles, instead of Pi-measurable plans of bundles as in Radner (1968). In equilibrium, the price of a list coincides with the price of the cheapest bundle in the list, and it is always the cheapest bundle of the list that is delivered. This property leads to a system of linear inequalities which are deliverability constraints on the choice set. We investigate existence of equilibrium in the case in which preferences are Pi-measurable. If there is a perfectly informed trader in the economy, existence of equilibrium is guaranteed.
    Keywords: General equilibrium, Differential information, Verifiability, Uncertain delivery, Lists of bundles, Rational expectations
    JEL: C62 D51 D82
    Date: 2008–03
  4. By: Dittmann, Ingolf (Erasmus School of Economics Rotterdam); Maug, Ernst (Chair for Corporate Finance, University of Mannheim and Sonderforschungsbereich 504); Spalt, Oliver (Chair for Corporate Finance, University of Mannheim and Sonderforschungsbereich 504)
    Abstract: This paper analyzes optimal executive compensation contracts when managers are loss averse. We establish the general optimal contract analytically and parameterize the model using data on compensation contracts for 595 CEOs. Parameters for preferences are based on the experimental literature. Overall, the Loss Aversion-model dominates an equivalent Risk Aversion-model, especially with respect to its ability to predict options as part of the optimal contract. The Loss Aversion-model performs well in terms of predicting observed compensation contracts if the reference wage is assumed to lie not too far above previous year’s fixed wage. Our results suggest that loss aversion is a better paradigm for analyzing design features of stock options and for developing preference-based valuation models than the conventional model used in the literature.
    Date: 2007–06–26
  5. By: Maug, Ernst (Chair for Corporate Finance, University of Mannheim and Sonderforschungsbereich 504); Dittmann, Ingolf (Erasmus School of Economics Rotterdam)
    Abstract: We estimate a standard principal agent model with constant relative risk aversion and lognormal stock prices for a sample of 598 US CEOs. The model is widely used in the compensation literature, but it predicts that almost all of the CEOs in our sample should hold no stock options. Instead, CEOs should have lower base salaries and receive additional shares in their companies. For a typical value of relative risk aversion, almost half of the CEOs in our sample would be required to purchase additional stock in their companies from their private savings. The model predicts contracts that would reduce average compensation costs by 20% while providing the same incentives and the same utility to CEOs. We investigate a number of extensions and modi.cations of the standard model, but .nd none of them to be satisfactory. We conclude that the standard principal agent model typically used in the literature cannot rationalize observed contracts. One reason may be that executive pay contracts are suboptimal.
    Date: 2007–06–26

This nep-cta issue is ©2008 by Simona Fabrizi. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
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