Working Paper: CEPR ID: DP15755
Authors: Pierre Chaigneau; Alex Edmans; Daniel Gottlieb
Abstract: The informativeness principle demonstrates that a contract should depend on informative signals. This paper studies how it should do so. Signals that indicate the output distribution has shifted to the left (e.g. weak industry performance) reduce the threshold for the manager to be paid; those that indicate output is a precise measure of effort (e.g. low volatility) decrease high thresholds and increase low thresholds. Surprisingly, "good" signals of performance need not reduce the threshold. Applying our model to performance-based vesting, we show that performance measures should affect the strike price rather than the number of vesting options, contrary to practice.
Keywords: informativeness principle; limited liability; option repricing; pay-for-luck; performance-based vesting; performance-sensitive debt
JEL Codes: D86; G32; G34; J33
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| signals indicating high effort (J24) | lower thresholds for manager payments (J33) |
| good signals (C58) | complicate relationship with thresholds (C32) |
| signals indicating a leftward shift in the output distribution (D39) | decrease the threshold (C24) |
| higher precision signals (C58) | increase or decrease the threshold (C24) |
| performance signals (L25) | modify both the threshold and slope of contracts (D86) |