Dynamic managerial compensation: A variational approach

Daniel F. Garrett, Alessandro Pavan*

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

14 Scopus citations

Abstract

We study the optimal dynamics of incentives for a manager whose ability to generate cash flows changes stochastically with time and is his private information. We show that distortions (aka, wedges) under optimal contracts may either increase or decrease over time. In particular, when the manager's risk aversion and ability persistence are small, distortions decrease, on average, over time. For sufficiently high degrees of risk aversion and ability persistence, instead, distortions increase, on average, with tenure. Our results follow from a novel variational approach that permits us to tackle directly the "full program," thus bypassing some of the difficulties of the "first-order approach" encountered in the dynamic mechanism design literature.

Original languageEnglish (US)
Pages (from-to)775-818
Number of pages44
JournalJournal of Economic Theory
Volume159
DOIs
StatePublished - Sep 1 2015

Keywords

  • Adverse selection
  • Dynamic mechanism design
  • Incentives
  • Moral hazard
  • Persistent productivity shocks
  • Risk aversion

ASJC Scopus subject areas

  • Economics and Econometrics

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