week4B - Per for mance and Compensation Thomas Noe, Tulane...

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Unformatted text preview: Per for mance and Compensation Thomas Noe, Tulane University Over view Managerial rewards and performance The Firm mgr. owners rival management teams competitors creditors int. labor market/ contracts/competition Lectur e objective Students should understand how External labor markets Internal labor markets Compensation contracts can be combined to create compensation packages that align shareholder and managerial interests Exter nal Labor M ar ket Replacement by Board absent external pressure Fairly rare, according to Jensen and Murphy, (1990) not usually a significant factor unless firm is grossly underperforming relative to industry norms. The market for corporate control . Significant constraint on managerial opportunism. Exter nal labor mar ket Replacement/reputation loss related to financial distress Common, 64% of incumbent CEOs at the time of workout and/or bankruptcy lose jobs within 4 years. (Gilson, 1990) Exter nal Labor M ar ket: Summar y Constrains managerial opportunism However, high transactions costs leave room for other controls to effect improvement I nter nal Labor M ar ket: The agency relationship Agency Relationships Definition: one individual, the agent, is hired by another individual, the principal, to increase the value of an asset the principal owns. Examples of Agency Relationships doctor/patient expert/client Agency The agency contract what the agent will receive given actions taken by agent outcomes observed by principal Constraints on agency contract verifiability incentive compatibility voluntary participation Agency Verifiability--The values of the variables contracted on must be capable of verification by outside parties Incentive compatibility--It must be in the agents interest to undertake the actions called for in the contract. Voluntary Participation--agent must be willing to accept the contract offered by the principal. Agency Issues in Contract Design verifiability vs. observability--some variables are observable by all interested parties but their values cannot be verified by third parties limited liability--optimal design cannot force the agent consumption below some fixed lower limit (say zero). Agency risk aversion--If the agent is risk averse, and the relationship between effort and contractible variables is noisy, the agent will require a premium for bearing the risks associated with high-powered incentive contract, making such contracts very expensive, and possible unattractive to the principal. Example: Agency Manager hired to manage an asset Managers effort is not verifiable but the firms value is observable....
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week4B - Per for mance and Compensation Thomas Noe, Tulane...

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